LIBRARY 

UNIVERSITY  OF 
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SAN  DIEGO 


1 


THE  MACMILLAN  COMPANY 

NEW  YORK  •    BOSTON  •   CHICAGO  •   DALLAS 
ATLANTA  •    SAN  FRANCISCO 

MACMILLAN  &  CO.,  LIMITED 

LONDON  •    BOMBAY  •    CALCUTTA 
MELBOURNE 

THE  MACMILLAN  CO.  OF  CANADA,  L 

TORONTO 


READINGS    IN    MONEY 
AND    BANKING 

SELECTED  AND  ADAPTED 


BY 


ASSISTANT  PROFESSOR  OF  ECONOMICS  IN  DARTMOUTH  COLLEGE 

AND  ASSISTANT  PROFESSOR  OF  BANKING  IN  THE  AMOS 

TUCK  SCHOOL  OK  ADMINISTRATION  AND  FINANCE 


THE  MACMILLAN  COMPANY 

1921 

All  rights  reserved 


PRINTED  IN  THE  UNITED  STATES  OF  AMERICA 


Copyright  1916 
By  THE  MACMILLAN  COMPANY 

Set  up  and  electrotyped.    Published  September,  1916. 


FERRIS 

PRINTING  COMPANY 
NEW  YORK  CITY 


PREFACE 

Designed  mainly  for  class  room  use  in  connection  with  one 
of  the  introductory  manuals  on  the  subject  of  Money  and 
Banking  or  of  Money  and  Currency,  this  volume,  in  itself, 
lays  no  claim  to  completeness.  Where  its  use  is  contem- 
plated the  problems  of  emphasis  and  proportion  are,  accord- 
ingly, to  be  solved  by  the  selection  of  one  or  another  of  the 
available  texts,  or  by  the  choice  of  supplementary  lecture  topics 
and  materials.  The  contents  of  the  introductory  manuals  are 
so  divergent  in  character  as  to  render  possible  combinations  of 
text  and  readings  that  will  include,  it  is  hoped,  matter  of  such 
range  and  variety  as  may  be  desired. 

Fullness  of  treatment  has  been  attempted,  however,  in  the 
chapters  dealing  with  the  important  recent  developments  in 
the  "  mechanism  of  exchange,"  and  my  aim  has  been  through- 
out to  select  and,  in  many  instances,  to  adapt  with  a  view  to 
meeting  the  wants  of  those  who  are  interested  chiefly  in  the 
modern  phases  of  the  subject. 

For  valuable  suggestions  in  the  preparation  of  the  volume 
I  am  greatly  indebted  to  Professors  F.  H.  Dixon  and  G.  R. 
Wicker  and  Mr.  J.  M.  Shortliffe  of  Dartmouth,  Professor 
Hastings  Lyon  of  Columbia,  Professor  E.  E.  Day  of  Harvard, 
and  to  my  former  teacher,  Professor  F.  R.  Fairchild  of  Yale. 
I  desire  also  to  mention  my  great  obligation  to  authors  and 
publishers  who  alike  have  generously  permitted  the  reproduc- 
tion of  copyrighted  material. 

CHESTER  ARTHUR  PHILLIPS. 
Dartmouth  College, 

Hanover,  N.  H.,  July,  1916. 


XI 

XII 

XIII 

XIV 

XV 

XVI 

XVII 

XVIII 

XIX 

XX 

XXI 

XXII 

XXIII 

XXIV 

XXV 

XXVI 

XXVII 

XXVIII 

XXIX 
XXX 


XXXI 
XXXII 


PAGE 

THE  ORIGIN  AND  FUNCTIONS  OF  MONEY  .....       I 

THE  EARLY  HISTORY  OF  MONEY 10 

QUALITIES  OF  THE  MATERIAL  OF  MONEY 18 

LEGAL  TENDER 26 

THE  GREENBACK  ISSUES 33 

INTERNATIONAL  BIMETALLISM        71 

THE  SILVER  QUESTION  IN  THE  UNITED  STATES  ...     82 

INDEX  NUMBERS 115 

BANKING  OPERATIONS  AND  ACCOUNTS     .....   121 
THE  USE  OF  CREDIT  INSTRUMENTS  IN  PAYMENTS  IN  THE 

UNITED  STATES 150 

A  SYMPOSIUM  ON  THE  RELATION  BETWEEN  MONEY  AND 

GENERAL  PRICES 159 

THE  GOLD  EXCHANGE  STANDARD 213 

A  PLAN  FOR  A  COMPENSATED  DOLLAR 229 

MONETARY  SYSTEMS  OF  FOREIGN  COUNTRIES  ....  246 
THE  NATURE  AND  FUNCTIONS  OF  TRUST.  COMPANIES    .  256 

SAVINGS  BANKS 270 

DOMESTIC  EXCHANGE 290 

FOREIGN  EXCHANGE 305 

CLEARING  HOUSES 355 

STATE  BANKS  AND  TRUST  COMPANIES  SINCE  THE  PAS- 
SAGE OF  THE  NATIONAL  BANK  ACT 381 

THE  CANADIAN  BANKING  SYSTEM 406 

THE  ENGLISH  BANKING  SYSTEM 435 

THE  SCOTCH  BANKS' 474 

THE  FRENCH  BANKING  SYSTEM 488 

THE  GERMAN  BANKING  SYSTEM 526 

BANKING  IN  SOUTH  AMERICA 559 

AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES  .     .     .  575 
THE    CONCENTRATION    OF    CONTROL    OF    MONEY    AND 

CREDIT 606 

CRISES 627 

THE  WEAKNESSES  OF  OUR  BANKING  SYSTEM  PRIOR  TO 
THE  ESTABLISHMENT  OF  THE  FEDERAL  RESERVE  SYS- 
TEM   672 

THE  FEDERAL  RESERVE  SYSTEM 723 

THE  EUROPEAN  WAR  IN  RELATION  TO  MONEY,  BANK- 
ING AND  FINANCE .  797 

APPENDICES 830 


CHAPTER  I 
THE  ORIGIN  AND  FUNCTIONS  OF  MONEY 

1  IN  order  to  understand  the  manifold  functions  of  a  Circu- 
lating Medium,  there  is  no  better  way  than  to  consider  what  are 
the  principal  inconveniences  which  we  should  experience  if  we 
had  not  such  a  medium.  The  first  and  most  obvious  would  be 
the  want  of  a  common  measure  for  values  of  different  sorts. 
If  a  tailor  had  only  coats,  and  wanted  to  buy  bread  or  a  horse, 
it  would  be  very  troublesome  to  ascertain  how  much  bread  he 
ought  to  obtain  for  a  coat,  or  how  many  coats  he  should  give 
for  a  horse.  The  calculation  must  be  recommenced  on  differ- 
ent data,  every  time  he  bartered  his  coats  for  a  different  kind 
of  article;  and  there  could  be  no  current  price,  or  regular  quo- 
tations of  value.  Whereas  now  each  thing  has  a  current 
price  in  money,  and  he  gets  over  all  difficulties  by  reckoning  his 
coat  at  £4  or  £5,  and  a  four-pound  loaf  at  6d.  or  jd.  As  it 
is  much  easier  to  compare  different  lengths  by  expressing  them 
in  a  common  language  of  feet  and  inches,  so  it  is  much  easier 
to  compare  values  by  means  of  a  common  language  of  pounds, 
shillings,  and  pence.  In  no  other  way  can  values  be  arranged 
one  above  another  in  a  scale ;  in  no  other  can  a  person  con- 
veniently calculate  the  sum  of  his  possessions ;  and  it  is  easier 
to  ascertain  and  remember  the  relations  of  many  things  to  one 
thing,  than  their  innumerable  cross  relations  with  one  another. 
This  advantage  of  having  a  common  language  in  which  values 
may  be  expressed,  is,  even  by  itself,  so  important,  that  some 
such  mode  of  expressing  and  computing  them  would  probably 

1  John  Stuart  Mill,  Principles  of  Political  Economy,  Vol.  II,  pp.  17-23. 

I 


2  THE  ORIGIN  AND  FUNCTIONS  OF  MONEY 

be  used  even  if  a  pound  or  a  shilling  did  not  express  any  real 
thing,  but  a  mere  unit  of  calculation.  It  is  said  that  there  are 
African  tribes  in  which  this  somewhat  artificial  contrivance 
actually  prevails.  They  calculate  the  value  of  things  in  a  sort 
of  money  of  account,  called  macutes.  They  say,  one  thing  is 
worth  ten  macutes,  another  fifteen,  another  twenty.  There  is 
no  real  thing  called  a  macute :  it  is  a  conventional  unit,  for  the 
more  convenient  comparison  of  things  with  one  another. 

This  advantage,  however,  forms  but  an  inconsiderable  part 
of  the  economical  benefits  derived  from  the  use  of  money. 
The  inconveniences  of  barter  are  so  great,  that  without  some 
more  commodious  means  of  effecting  exchanges,  the  division  of 
employments  could  hardly  have  been  carried  to  any  considerable 
extent.  A  tailor,  who  had  nothing  but  coats,  might  starve  be- 
fore he  could  find  any  person  having  bread  to  sell  who  wanted 
a  coat :  besides,  he  would  not  want  as  much  bread  at  a  time  as 
would  be  worth  a  coat,  and  the  coat  could  not  be  divided. 
Every  person,  therefore,  would  at  all  times  hasten  to  dispose 
of  his  commodity  in  exchange  for  anything  which,  though  it 
might  not  be  fitted  to  his  own  immediate  wants,  was  in  great 
and  general  demand,  and  easily  divisible,  so  that  he  might  be 
sure  of  being  able  to  purchase  with  it,  whatever  was  offered  for 
sale.  The  primary  necessaries  of  life  possess  these  properties 
in  a  high  degree.  Bread  is  extremely  divisible,  and  an  object 
of  universal  desire.  Still,  this  is  not  the  sort  of  thing  required  : 
for,  of  food,  unless  in  expectation  of  a  scarcity,  no  one  wishes 
to  possess  more  at  once  than  is  wanted  for  immediate  consump- 
tion; so  that  a  person  is  never  sure  of  finding  an  immediate 
purchaser  for  articles  of  food;  and  unless  soon  disposed  of, 
most  of  them  perish.  The  thing  which  people  would  select  to 
keep  by  them  for  making  purchases,  must  be  one  which,  besides 
being  divisible,  and  generally  desired,  does  not  deteriorate 
by  keeping.  This  reduces  the  choice  to  a  small  number 
of  articles. 

By  a  tacit  concurrence,  almost  all  nations,  at  a  very  early 
period,  fixed  upon  certain  metals,  and  especially  gold  and  silver, 
to  serve  this  purpose.  No  other  substances  unite  the  necessary 
qualities  in  so  great  a  degree,  with  so  many  subordinate  ad- 
vantages. Next  to  food  and  clothing,  and  in  some  climates 


SUPERIORITY  OF  GOLD  AND  SILVER  3 

even  before  clothing,  the  strongest  inclination  in  a  rude  state 
of  society  is  for  personal  ornament,  and  for  the  kind  of  distinc- 
tion which  is  obtained  by  rarity  or  costliness  in  such  ornaments. 
After  the  immediate  necessities  of  life  were  satisfied,  every  one 
was  eager  to  accumulate  as  great  a  store  as  possible  of  things  at 
once  costly  and  ornamental ;  which  were  chiefly  gold,  silver,  and 
jewels.  These  were  the  things  which  it  most  pleased  every 
one  to  possess,  and  which  there  was  most  certainty  of  finding 
others  willing  to  receive  in  exchange  for  any  kind  of  produce. 
They  were  among  the  most  imperishable  of  all  substances. 
They  were  also  portable,  and  containing  great  value  in  small 
bulk,  were  easily  hid;  a  consideration  of  much  importance  in 
an  age  of  insecurity.  Jewels  are  inferior  to  gold  and  silver  in 
the  quality  of  divisibility ;  and  are  of  very  various  qualities, 
not  to  be  accurately  discriminated  without  great  trouble.  Gold 
and  silver  are  eminently  divisible,  and  when  pure,  always  of 
the  same  quality ;  and  their  purity  may  be  ascertained  and  certi- 
fied by  a  public  authority. 

Accordingly,  though  furs  have  been  employed  as  money  in 
some  countries,  cattle  in  others,  in  Chinese  Tartary  cubes  of 
tea  closely  pressed  together,  the  shells  called  cowries  on  the 
coast  of  Western  Africa,  and  in  Abyssinia  at  this  day  blocks 
of  rock  salt ;  though  even  of  metals,  the  less  costly  have  some- 
times been  chosen,  as  iron  in  Lacedsemon  from  ascetic  policy, 
copper  in  the  early  Roman  republic  from  the  poverty  of  the 
people;  gold  and  silver  have  been  generally  preferred  by  na- 
tions which  were  able  to  obtain  them,  either  by  industry, 
commerce,  or  conquest.  To  the  qualities  which  originally 
recommended  them,  another  came  to  be  added,  the  importance 
of  which  only  unfolded  itself  by  degrees.  Of  all  commodities, 
they  are  among  the  least  influenced  by  any  of  the  causes  which 
produce  fluctuations  of  value.  They  fluctuate  less  than  al- 
most any  other  things  in  their  cost  of  production.  And  from 
their  durability,  the  total  quantity  in  existence  is  at  all  times 
so  great  in  proportion  to  the  annual  supply,  that  the  effect  on 
value  even  of  a  change  in  the  cost  of  production  is  not  sudden : 
a  very  long  time  being  required  to  diminish  materially  the 
quantity  in  existence,  and  even  to  increase  it  very  greatly  not 
being  a  rapid  process.  Gold  and  silver,  therefore,  are  more 


4  THE  ORIGIN  AND  FUNCTIONS  OF  MONEY 

fit  than  any  other  commodity  to  be  the  subject  of  engagements 
for  receiving  or  paying  a  given  quantity  at  some  distant  period. 
If  the  engagement  were  made  in  corn,  a  failure  of  crops  might 
increase  the  burthen  of  the  payment  in  one  year  to  fourfold 
what  was  intended,  or  an  exuberant  harvest  sink  it  in  another 
to  one- fourth.  If  stipulated  in  cloth,  some  manufacturing  in- 
vention might  permanently  reduce  the  payment  to  a  tenth  of 
its  original  value.  Such  things  have  occurred  even  in  the  case 
of  payments  stipulated  in  gold  and  silver;  but  the  great  fall  of 
their  value  after  the  discovery  of  America,  is,  as  yet,  the  only 
authenticated  instance;  and  in  this  case  the  change  was  ex- 
tremely gradual,  being  spread  over  a  period  of  many  years. 

When  gold  and  silver  had  become  virtually  a  medium  of  ex- 
change, by  becoming  the  things  for  which  people  generally 
sold,  and  with  which  they  generally  bought,  whatever  they  had 
to  sell  or  to  buy;  the  contrivance  of  coining  obviously  sug- 
gested itself.  By  this  process  the  metal  was  divided  into  con- 
venient portions,  of  any  degree  of  smallness,  and  bearing  a 
recognized  proportion  to  one  another;  and  the  trouble  was 
saved  of  weighing  and  assaying  at  every  change  of  possessors, 
an  inconvenience  which  on  the  occasion  of  small  purchases 
would  soon  have  become  insupportable.  Governments  found 
it  their  interest  to  take  the  operation  into  their  own  hands,  and 
to  interdict  all  coining  by  private  persons ;  indeed,  their  guar- 
antee was  often  the  only  one  which  would  have  been  relied 
on,  a  reliance  however  which  very  often  it  ill  deserved; 
profligate  governments  having  until  a  very  modern  period  sel- 
dom scrupled,  for  the  sake  of  robbing  their  creditors,  to  con- 
fer on  all  other  debtors  a  licence  to  rob  theirs,  by  the  shallow 
and  impudent  artifice  of  lowering  the  standard;  that  least 
covert  of  all  modes  of  knavery,  which  consists  in  calling  a 
shilling  a  pound,  that  a  debt  of  a  hundred  pounds  may  be  can- 
celled by  the  payment  of  a  hundred  shillings.  It  would  have 
been  as  simple  a  plan,  and  would  have  answered  the  purpose 
as  well,  to  have  enacted  that  "  a  hundred  "  should  always  be 
interpreted  to  mean  five,  which  would  have  effected  the  same 
reduction  in  all  pecuniary  contracts,  and  would  not  have  been 
at  all  more  shameless.  Such  strokes  of  policy  have  not  wholly 
ceased  to  be  recommended,  but  they  have  ceased  to  be  prac- 


MONEY  AS  TICKETS  FOR  GOODS  5 

tised;  except  occasionally  through  the  medium  of  paper  money, 
in  which  case  the  character  of  the  transaction,  from  the  greater 
obscurity  of  the  subject,  is  a  little  less  barefaced. 

Money,  when  its  use  has  grown  habitual,  is  the  medium 
through  which  the  incomes  of  the  different  members  of  the 
community  are  distributed  to  them,  and  the  measure  by  which 
they  estimate  their  possessions.  As  it  is  always  by  means  of 
money  that  people  provide  for  their  different  necessities,  there 
grows  up  in  their  minds  a  powerful  association  leading  them 
to  regard  money  as  wealth  in  a  more  peculiar  sense  than  any 
other  article;  and  even  those  who  pass  their  lives  in  the  pro- 
duction of  the  most  useful  objects,  acquire  the  habit  of  regard- 
ing those  objects  as  chiefly  important  by  their  capacity  of  being 
exchanged  for  money.  A  person  who  parts  with  money  to 
obtain  commodities,  unless  he  intends  to  sell  them,  appears  to 
the  imagination  to  be  making  a  worse  bargain  than  a  person 
who  parts  with  commodities  to  get  money;  the  one  seems  to 
be  spending  his  means,  the  other  adding  to  them.  Illusions 
which,  though  now  in  some  measure  dispelled,  were  long 
powerful  enough  to  overmaster  the  mind  of  every  politician, 
both  speculative  and  practical,  in  Europe. 

It  must  be  evident,  however,  that  the  mere  introduction  of 
a  particular  mode  of  exchanging  things  for  one  another,  by 
first  exchanging  a  thing  for  money,  and  then  exchanging  the 
money  for  something  else,  makes  no  difference  in  the  essential 
character  of  transactions.  It  is  not  with  money  that  things 
are  really  purchased.  Nobody's  income  (except  that  of  the 
gold  or  silver  miner)  is  derived  from  the  precious  metals. 
The  pounds  or  shillings  which  a  person  receives  weekly  or 
yearly,  are  not  what  constitutes  his  income ;  they  are  a  sort  of 
tickets  or  orders  which  he  can  present  for  payment  at  any 
shop  he  pleases,  and  which  entitle  him  to  receive  a  certain 
value  of  any  commodity  that  he  makes  choice  of.  The 
farmer  pays  his  laborers  and  his  landlord  in  these  tickets, 
as  the  most  convenient  plan  for  himself  and  them ;  but  their 
real  income  is  their  share  of  his  corn,  cattle,  and  hay,  and  it 
makes  no  essential  difference  whether  he  distributes  it  to  them 
directly  or  sells  it  for  them  and  gives  them  the  price ;  but  as 
they  would  have  to  sell  it  for  money  if  he  did  not,  and  he  is 


6  THE  ORIGIN  AND  FUNCTIONS  OF  MONEY 

a  seller  at  any  rate,  it  best  suits  the  purposes  of  all,  that  he 
should  sell  their  share  along  with  his  own,  and  leave  the 
laborers  more  leisure  for  work  and  the  landlord  for  being 
idle.  The  capitalists,  except  those  who  are  producers  of  the 
precious  metals,  derive  no  part  of  their  income  from  those 
metals,  since  they  only  get  them  by  buying  them  with  their  own 
produce:  while  all  other  persons  have  their  incomes  paid  to 
them  by  the  capitalists,  or  by  those  who  have  received  payment 
from  the  capitalists,  and  as  the  capitalists  have  nothing,  from 
the  first,  except  their  produce,  it  is  that  and  nothing  else 
which  supplies  all  incomes  furnished  by  them.  There  can- 
not, in  short,  be  intrinsically  a  more  insignificant  thing,  in  the 
economy  of  society,  than  money;  except  in  the  character  of  a 
contrivance  for  sparing  time  and  labor.  It  is  a  machine  for 
doing  quickly  and  commodiously,  what  would  be  done,  though 
less  quickly  and  commodiously,  without  it:  and  like  many 
other  kinds  of  machinery,  it  only  exerts  a  distinct  and  inde- 
pendent influence  of  its  own  when  it  gets  out  of  order. 

The  introduction  of  money  does  not  interfere  with  the 
operation  of  any  of  the  Laws  of  Value.  .  .  .  The  reasons 
which  make  the  temporary  or  market  value  of  things  depend 
on  the  demand  and  supply,  and  their  average  and  permanent 
values  upon  their  cost  of  production,  are  as  applicable  to  a 
money  system  as  to  a  system  of  barter.  Things  which  by 
barter  would  exchange  for  one  another,  will,  if  sold  for 
money,  sell  for  an  equal  amount  of  it,  and  so  will  exchange 
for  one  another  still,  though  the  process  of  exchanging  them 
will  consist  of  two  operations  instead  of  only  one.  The  re- 
lations of  commodities  to  one  another  remain  unaltered  by 
money:  the  only  new  relation  introduced,  is  their  relation  to 
money  itself;  how  much  or  how  little  money  they  will  ex- 
change for;  in  other  words,  how  the  Exchange  Value  of  money 
itself  is  determined.  And  this  is  not  a  question  of  any  diffi- 
culty, when  the  illusion  is  dispelled,  w-hich  caused  money  to 
be  looked  upon  as  a  peculiar  thing,  not  governed  by  the  same 
laws  as  other  things.  Money  is  a  commodity,  and  its  value  is 
determined  like  that  of  other  commodities,  temporarily  by 
demand  and  supply,  permanently  and  on  the  average  by  cost 
of  production. 


STANDARD  OF  DEFERRED  PAYMENTS  7 

In  the  foregoing,1  attention  has  been  directed  mainly  to 
the  two  functions  of  money  known  (i)  as  the  Standard  or 
Common  Denominator  of  Value,  and  (2)  as  the  Medium  of 
Exchange.  Concerning  transactions  begun  and  ended  on  the 
spot  nothing  more  need  be  said ;  but  the  fact  of  contracts  over 
a  period  of  time  introduces  an  important  element  —  the  time 
element.  Whenever  a  contract  is  made  covering  a  period  of 
time,  within  which  serious  changes  in  the  economic  world  may 
take  place,  then  difficulties  may  arise  as  to  what  is  a  just  stand- 
ard of  payments.  Various  articles  might  serve  equally  well 
as  a  standard  for  exchanges  performed  on  the  spot,  but  it  is 
not  so  when  any  one  article  is  chosen  as  a  standard  for  de- 
ferred payments.  Without  much  regard  to  theory,  the  world 
has  in  fact  used  the  same  standard  for  transactions  whether 
settled  on  the  spot,  or  whether  extending  over  a  period  of 
time. 

In  order  to  work  with  perfection  as  a  standard  for  deferred 
payments,  the  article  chosen  as  that  standard  should  place  both 
debtors  and  creditors  in  exactly  the  same  absolute,  and  the 
same  relative,  position  to  each  other  at  the  end  of  a  contract 
that  they  occupied  at  its  beginning;  this  implies  that  the  chosen 
article  should  maintain  the  same  exchange  value  in  relation 
to  goods,  rents,  and  the  wages  of  labour  at  the  end  as  at 
the  beginning  of  the  contract,  and  it  implies  that  the  bor- 
rower and  lender  should  preserve  the  same  relative  position 
as  regards  their  fellow  producers  and  consumers  at  the  later 
as  at  the  earlier  point  of  time,  and  that  they  have  not  changed 
this  relation,  one  at  the  loss  of  the  other.  This  makes  de- 
mands which  any  article  that  can  be  suggested  as  a  standard 
cannot  satisfy.  And  yet  it  is  a  practical  necessity  of  society 
that  some  one  article  should  in  fact  be  selected  as  the  standard. 
The  business  world  has  thus  been  forced  to  find  some  com- 
modity which  —  while  admittedly  never  capable  of  perfec- 
tion —  provides  more  nearly  than  anything  else  all  the  essen- 
tials of  a  desirable  standard. 

The  causes  which  may  bring  about  changes  in  the  relations 
between  goods  and  labor,  on  the  one  side,  and  the  standard,  on 

1  Adapted    from    The   Report   of   the    Commission   of    the   Indianapolis 
Convention,  pp.  92,  93,  103,  104.     The  University  of  Chicago  Press,  1898. 


8  THE  ORIGIN  AND  FUNCTIONS  OF  MONEY 

the  other,  are  various.  We  may,  for  instance,  compare  wheat 
with  the  existing  gold  standard.  The  quantity  of  gold  for 
which  the  wheat  will  exchange  is  its  price.  As  wheat  falls  in 
value  relatively  to  gold,  it  exchanges  for  less  gold,  that  is,  its 
price  falls ;  or,  vice  versa,  gold  exchanges  for  more  wheat,  and 
relatively  to  wheat  gold  has  risen.  As  one  goes  up,  the  other 
term  in  the  ratio  necessarily  goes  down;  just  as  certainly  as  a 
rise  in  one  end  of  a  plank  balanced  on  a  log  necessitates  a  fall 
in  the  other  end  of  the  plank.  Therefore,  changes  in  prices 
can  be  caused  by  forces  affecting  either  the  gold  side  or  the 
wheat  side  of  the  ratio;  by  forces  affecting  either  the  money 
standard  or  the  goods  compared  with  that  standard.  Conse- 
quences of  importance  follow  from  this  explanation.  First 
suppose  that  commodities  and  labor  remain  unchanged  in  their 
production  and  reward,  respectively;  then,  anything  affecting 
the  supply  of  and  demand  for  gold  will  affect  in  general  the 
value  of  gold  in  comparison  with  goods  and  labor.  Or,  sec- 
ond, if  we  suppose  an  equilibrium  between  the  demand  for  and 
supply  of  gold,  then,  prices  and  wages  can  be  affected  also  by 
anything  affecting  the  cost  of  obtaining  goods  or  labor.  It 
is  one-sided  to  look  for  changes  in  prices  solely  from  causes 
touching  gold,  or  one  term  of  the  price  ratio.  If,  however, 
it  should  be  desired  that  prices  should  remain  stationary,  then 
this  can  be  brought  about  only  by  finding  for  the  standard  an 
article  that  would  automatically  move  in  extent,  and  in  the 
proper  compensating  direction,  so  as  to  meet  any  changes  in 
value  arising  not  only  from  causes  affecting  itself,  but  also 
from  causes  affecting  labor  and  the  vast  number  of  goods 
that  may  be  quoted  in  price.  No  commodity  ever  existed 
which  could  thus  move  in  value. 

During  long  periods  of  time  —  within  which  gains  in 
mechanical  skill  and  invention,  revolutions  in  political  and 
social  habits,  changes  in  taste  or  fashion,  settlement  of  new 
countries,  opening  of  new  markets,  may  take  place  —  great 
alterations  in  the  value  of  the  standard  may  occur  wholly 
from  natural  causes  affecting  the  commodity  side  of  the  price 
ratio.  And  yet,  in  default  of  a  perfect  standard,  persons  who 
borrow  and  lend  create  debts  and  obligations  expressed  in 
terms  of  that  article  which  has  been  adopted  as  the  standard 


STANDARD  OF  DEFERRED  PAYMENTS  9 

by  the  concurring  habits  of  the  commercial  community  of 
which  they  form  a  part.  It  should  be  understood,  whenever 
men  enter' into  obligations  reaching  over  a  period  of  time,  that 
a  necessary  part  of  the  risks  involved  in  this  undertaking  is 
the  possibility  of  an  alteration  in  the  exchange  values  of  goods, 
on  the  one  hand,  and  in  the  standard  metal  on  the  other,  due 
to  industrial  changes  and  natural  causes.  This  is  one  of  the 
risks  which  belong  to  individual  enterprise,  differing  in  no 
way  from  other  possibilities  of  gain  and  loss.  For  instance, 
prices  rose,  as  indicated  by  an  index  number  of  100  in  1860 
to  an  index  number  of  216  in  1865.  Therefore,  in  the  United 
States,  in  this  period  of  rising  prices  the  creditor  lost  and  the 
debtor  gained.  On  the  other  hand,  from  1865  to  1878,  prices 
fell  from  216  to  101,  and  in  this  period  of  falling  prices  the 
creditor  gained  and  the  debtor  lost.  It  is  to  be  observed, 
however,  that  these  figures  refer  to  actual  quotations  of  prices 
during  the  fluctuations  of  our  paper  money.  But  it  is  evident 
in  such  movements  as  these,  that  parties  to  a  time-contract 
must  take  their  own  chances  of  changes;  and  indeed  it  is  much 
more  wholesome  that  they  should  do  so. 

It  should  be  kept  well  in  mind  that  it  is  not  a  proper  func- 
tion of  government  to  step  in  and  save  men  from  the  ordinary 
risks  of  trade  and  industry.  It  goes  without  saying  that  if 
changes  in  the  value  of  the  standard  due  to  natural  causes  take 
place  during  the  continuance  of  a  contract,  it  is  not  the  busi- 
ness of  government  to  indemnify  either  party  to  the  contract. 
This  is  a  matter  on  which  every  individual  who  enters  into 
time  obligations  must  bear  his  own  responsibility. 


CHAPTER  II 
THE  EARLY  HISTORY  OF  MONEY 

1  LIVING  in  civilized  communities,  and  accustomed  to  the  use 
of  coined  metallic  money,  we  learn  to  identify  money  with 
gold  and  silver;  hence  spring  hurtful  and  insidious  fallacies. 
It  is  always  useful,  therefore,  to  be  reminded  of  the  truth,  so 
well  stated  by  Turgot,  that  every  kind  of  merchandise  has  the 
two  properties  of  measuring  value  and  transferring  value.  It 
is  entirely  a  question  of  degree  what  commodities  will  in  any 
given  state  of  society  form  the  most  convenient  currency,  and 
this  truth  will  be  best  impressed  upon  us  by  a  brief  considera- 
tion of  the  very  numerous  things  which  have  at  one  time  or 
other  been  employed  as  money.  Though  there  are  many 
numismatists  and  many  political  economists,  the  natural 
history  of  money  is  almost  .a  virgin  subject,  upon  which  I 
should  like  to  dilate ;  but  the  narrow  limits  of  my  space  forbid 
me  from  attempting  more  than  a  brief  sketch  of  the  many 
interesting  facts  which  may  be  collected. 


Perhaps  the  most  rudimentary  state  of  industry  is  that  in 
which  subsistence  is  gained  by  hunting  wild  animals.  The 
proceeds  of  the  chase  would,  in  such  a  state,  be  the  property 
of  most  generally  recognized  value.  The  meat  of  the  animals 
captured  would,  indeed,  be  too  perishable  in  nature  to  be 
hoarded  or  often  exchanged;  but  it  is  otherwise  with  the 
skins,  which,  being  preserved  and  valued  for  clothing,  became 
one  of  the  earliest  materials  of  currency.  Accordingly,  there 
is  abundant  evidence  that  furs  or  skins  were  employed  as 
money  in  many  ancient  nations.  They  serve  this  purpose  to 
the  present  day  in  some  parts  of  the  world. 

1  W.  Stanley  Jevons,  Money  and  the  Mechanism  of  Exchange,  D.  Apple- 
ton  and  Company,  New  York,  1902,  pp.  19-28,  54,  55. 

10 


IN  THE  HUNTING  STATE  1 1 

In  the  book  of  Job  (ii,  4)  we  read,  "  Skin  for  skin,  yea,  all 
that  a  man  hath  will  he  give  for  his  life  " ;  a  statement  clearly 
implying  that  skins  were  taken  as  the  representative  of  value 
among  the  ancient  Oriental  nations.  Etymological  research 
shows  that  the  same  may  be  said  of  the  northern  nations  from 
the  earliest  times.  In  the  Esthonian  language  the  word  rdha 
generally  signifies  money,  but  its  equivalent  in  the  kindred 
Lappish  tongue  has  not  yet  altogether  lost  the  original  mean- 
ing of  skin  or  fur.  Leather  money  is  said  to  have  circulated 
in  Russia  as  late  as  the  reign  of  Peter  the  Great,  and  it  is 
worthy  of  notice,  that  classical  writers  have  recorded  tradi- 
tions to  the  effect  that  the  earliest  currency  used  at  Rome, 
Lacedsemon,  and  Carthage,  was  formed  of  leather. 

We  need  not  go  back,  however,  to  such  early  times  to 
study  the  use  of  rude  currencies.  In  the  traffic  of  the  Hud- 
son's Bay  Company  with  the  North  American  Indians,  furs, 
in  spite  of  their  differences  of  quality  and  size,  long  formed 
the  medium  of  exchange.  It  is  very  instructive,  and  cor- 
roborative of  the  previous  evidence  to  find  that  even  after  the 
use  of  coin  had  become  common  among  the  Indians  the  skin 
was  still  commonly  used  as  the  money  of  account.  Thus 
Whymper  says,  "  a  gun,  nominally  worth  about  forty  shillings, 
bought  twenty  '  skins.'  This  term  is  the  old  one  employed  by 
the  company.  One  skin  (beaver)  is  supposed  to  be  worth  two 
shillings,  and  it  represents  two  marten,  and  so  on.  You  heard 
a  great  deal  about '  skins  '  at  Fort  Yukon,  as  the  workmen  were 
also  charged  for  clothing,  etc.,  in  this  way." 

CURRENCY  IN  THE  PASTORAL  STATE 

In  the  next  higher  stage  of  civilization,  the  pastoral  state, 
sheep  and  cattle  naturally  form  the  most  valuable  and  negoti- 
able kind  of  property.  They  are  easily  transferable,  convey 
themselves  about,  and  can  be  kept  for  many  years,  so  that  they 
readily  perform  some  of  the  functions  of  money. 

We  have  abundance  of  evidence,  traditional,  written,  and 
etymological,  to  show  this.  In  the  Homeric  poems  oxen  are 
distinctly  and  repeatedly  mentioned  as  the  commodity  in  terms 
of  which  other  objects  are  valued.  The  arms  of  Diomed  are 
stated  to  be  worth  nine  oxen,  and  are  compared  with  those  of 


12  THE  EARLY  HISTORY  OF  MONEY 

Glaucos,  worth  one  hundred.  The  tripod,  the  first  prize  for 
wrestlers  in  the  23rd  Iliad,  was  valued  at  twelve  oxen,  and  a 
woman  captive,  skilled  in  industry,  at  four.  It  is  peculiarly 
interesting  to  find  oxen  thus  used  as  the  common  measure  of 
value,  because  from  other  passages  it  is  probable,  as  already 
mentioned,  that  the  precious  metals,  though  as  yet  uncoined, 
were  used  as  a  store  of  value,  and  occasionally  as  a  medium 
of  exchange.  The  several  functions  of  money  were  thus 
clearly  performed  by  different  commodities  at  this  early 
period. 

In  several  languages  the  name  for  money  is  identical  with 
that  of  some  kind  of  cattle  or  domesticated  animal.  It  is  gen- 
erally allowed  that  pecunia,  the  Latin  word  for  money,  is 
derived  from  pecus,  cattle.  From  the  Agamemnon  of 
^schylus  we  learn  that  the  figure  of  an  ox  was  the  sign  first 
impressed  upon  coins,  and  the  same  is  said  to  have  been  the 
case  with  the  earliest  issues  of  the  Roman  As.  Numismatic 
researches  fail  to  bear  out  these  traditions,  which  were  prob- 
ably invented  to  explain  the  connection  between  the  name  of 
the  coin  and  the  animal.  A  corresponding  connection  between 
these  notions  may  be  detected  in  much  more  modern  languages. 
Our  common  expression  for  the  payment  of  a  sum  of  money 
is  fee,  which  is  nothing  but  the  Anglo-Saxon  fcoh,  meaning 
alike  money  and  cattle,  a  word  cognate  with  the  German  inch, 
which  still  bears  only  the  original  meaning  of  cattle. 

In  the  ancient  German  codes  of  law,  fines  and  penalties  are 
actually  defined  in  terms  of  live-stock.  In  the  Zend  Avesta,  as 
Professor  Theodores  .  .  .  informs  me,  the  scale  of  rewards 
to  be  paid  to  physicians  is  carefully  stated,  and  in  every  case 
the  fee  consists  in  some  sort  of  cattle.  The  fifth  and  sixth 
lectures  in  Sir  H.  S.  Maine's  most  interesting  work  on  The 
Early  History  of  Institutions,  which  has  just  been  published, 
are  full  of  curious  information  showing  the  importance  of 
live-stock  in  a  primitive  state  of  society.  Being  counted  by 
the  head,  the  kine  was  called  capitale,  whence  the  economical 
term  capital,  the  law  term  chattel,  and  our  common  name 
cattle. 

In  countries  where  slaves  form  one  of  the  most  common 
and  valuable  possessions,  it  is  quite  natural  that  they  should 


IN  THE  PASTORAL  STATE  13 

serve  as  the  medium  of  exchange  like  cattle.  Pausanias  men- 
tions their  use  in  this  way,  and  in  Central  Africa  and  some, 
other  places  where  slavery  still  flourishes,  they  are  the  medium 
of  exchange  along  with  cattle  and  ivory  tusks.  According  to 
Earl's  account  of  New  Guinea,  there  is  in  that  island  a  large 
traffic  in  slaves,  and  a  slave  forms  the  unit  of  value.  Even  in 
England  slaves  are  believed  to  have  been  exchanged  at  one 
time  in  the  manner  of  money. 

ARTICLES  OF  ORNAMENT  AS  CURRENCY 

A  passion  for  personal  adornment  is  one  of  the  most  prim- 
itive and  powerful  instincts  of  the  human  race,  and  as  articles 
used  for  such  purposes  would  be  durable,  universally  esteemed, 
and  easily  transferable,  it  is  natural  that  they  should  be  cir- 
culated as  money.  The  wampumpeag  of  the  North  American 
Indians  is  a  case  in  point,  as  it  certainly  served  as  jewellery. 
It  consisted  of  beads  made  of  the  ends  of  black  and  white 
shells,  rubbed  down  and  polished,  and  then  strung  into  belts 
or  necklaces,  which  were  valued  according  to  their  length, 
and  also  according  to  their  color  and  luster,  a  foot  of  black 
peag  being  worth  two  feet  of  white  peag.  It  was  so  well 
established  as  currency  among  the  natives  that  the  Court  of 
Massachusetts  ordered  in  1649,  that  it  should  be  received  in 
the  payment  of  debts  among  settlers  to  the  amount  of  forty 
shillings.  It  is  curious  to  learn,  too,  that  just  as  European 
misers  hoard  up  gold  and  silver  coins,  the -richer  Indian  chiefs 
secrete  piles  of  wampum  beads,  having  no  better  means  of  in- 
vesting their  superfluous  wealth. 

Exactly  analogous  to  this  North  American  currency,  is  that 
of  the  cowry  shells,  which,  under  one  name  or  another  — 
chamgos,  ziiribis,  bouges,  porcelanes,  etc. — have  long  been  used 
in  the  East  Indies  as  small  money.  In  British  India,  Siam, 
the  West  Coast  of  Africa,  and  elsewhere  on  the  tropical  coasts, 
they  are  still  used  as  small  change,  being  collected  on  the 
shores  of  the  Maldive  and  Laccadive  Islands,  and  exported 
for  the  purpose.  Their  value  varies  somewhat,  according  to 
the  abundance  of  the  yield,  but  in  India  the  current  rate  used 
to  be  about  five  thousand  shells  for  one  rupee,  at  which  rate 
each  shell  is  worth  about  the  two-hundredth  part  cf  a  penny. 


14  THE  EARLY  HISTORY  OF  MONEY 

Among  our  interesting  fellow-subjects,  the  Fijians,  whale's 
teeth  served  in  the  place  of  cowries,  and  white  teeth  were  ex- 
changed for  red  teeth  somewhat  in  the  ratio  of  shillings  to 
sovereigns. 

Among  other  articles  of  ornament  or  of  special  value  used 
as  currency,  may  be  mentioned  yellow  amber,  engraved  stones, 
such  as  the  Egyptian  scarabsei,  and  tusks  of  ivory. 

CURRENCY  IN  THE  AGRICULTURAL  STATE 

Many  vegetable  productions  are  at  least  as  well  suited  for 
circulation  as  some  of  the  articles  which  have  been  men- 
tioned. It  is  not  surprising  to  find,  then,  that  among  a  people 
supporting  themselves  by  agriculture,  the  more  durable  prod- 
ucts were  thus  used.  Corn  has  been  the  medium  of  exchange 
in  remote  parts  of  Europe  from  the  time  of  the  ancient  Greeks 
to  the  present  day.  In  Norway  corn  is  even  deposited  in 
banks,  and  lent  and  borrowed.  What  wheat,  barley,  and 
oats  are  to  Europe,  such  is  maize  in  parts  of  Central  America, 
especially  Mexico,  where  it  formerly  circulated.  In  many  of 
the  countries  surrounding  the  Mediterranean,  olive  oil  is  one 
of  the  commonest  articles  of  produce  and  consumption;  being, 
moreover,  pretty  uniform  in  quality,  durable,  and  easily  di- 
visible, it  has  long  served  as  currency  in  the  Ionian  Islands, 
Mytilene,  some  towns  of  Asia  Minor,  and  elsewhere  in  the 
Levant. 

Just  as  cowries  circulate  in  the  East  Indies,  so  cacao  nuts, 
in  Central  America  and  Yucatan,  form  a  perfectly  recognized 
and  probably  an  ancient  fractional  money.  Travellers  have 
published  many  distinct  statements  as  to  their  value,  but  it  is 
impossible  to  reconcile  these  statements  without  supposing 
great  changes  of  value  either  in  the  nuts  or  in  the  coins  with 
which  they  are  compared.  In  1521,  at  Caracas,  about  thirty 
cacao  nuts  were  worth  one  penny  English,  whereas  recently 
ten  beans  would  go  to  a  penny,  according  to  Squier's  state- 
ments. In  the  European  countries,  where  almonds  are  com- 
monly grown,  they  have  circulated  to  some  extent  like  the 
cacao  nuts,  but  are  variable  in  value,  according  to  the  success 
of  the  harvest. 

It  is  not  only,  however,  as  a  minor  currency  that  vegetable 


IN  THE  AGRICULTURAL  STATE  l'5' 

products  have  been  used  in  modern  times.  In  the  American 
settlements  and  the  West  India  Islands,  in  former  days,  specie 
used  to  become  inconveniently  scarce,  and  the  legislators  fell 
back  upon  the  device  of  obliging  creditors  to  receive  payment 
in  produce  at  stated  rates.  In  1618,  the  Governor  of  the  Plan- 
tations of  Virginia  ordered  that  tobacco  should  be  received 
at  the  rate  of  three  shillings  for  the  pound  weight,  under  the 
penalty  of  three  years'  hard  labor.  We  are  told  that,  when 
the  Virginia  Company  imported  young  women  as  wives  for 
the  settlers,  the  price  per  head  was  one  hundred  pounds  of 
tobacco,  subsequently  raised  to  one  hundred  and  fifty.  As 
late  as  1732,  the  legislature  of  Maryland  made  tobacco  and 
Indian  corn  legal  tenders;  and  in  1641  there  were  similar  laws 
concerning  corn  in  Massachusetts.  The  governments  of  some 
of  the  West  India  Islands  seem  to  have  made  attempts  to 
imitate  these  peculiar  currency  laws,  and  it  was  provided  that 
the  successful  plaintiff  in  a  lawsuit  should  be  obliged  to  ac- 
cept various  kinds  of  raw  produce,  such  as  sugar,  rum,  mo- 
lasses, ginger,  indigo,  or  tobacco.  .  .  . 

The  perishable  nature  of  most  kinds  of  animal  food  pre- 
vents them  from  being  much  used  as  money ;  but  eggs  are  said 
to  have  circulated  in  the  Alpine  villages  of  Switzerland,  and 
dried  codfish  have  certainly  acted  as  currency  in  the  colony  of 
Newfoundland. 

MANUFACTURED  AND  MISCELLANEOUS  ARTICLES  AS 
CURRENCY 

The  enumeration  of  articles  which  have  served  as  money 
may  already  seem  long  enough  for  the  purposes  in  view.  I 
will,  therefore,  only  add  briefly  that  a  great  number  of  manu- 
factured commodities  have  been  used  as  a  medium  of  ex- 
change in  various  times  and  places.  Such  are  the  pieces  of 
cotton  cloth,  called  Guinea  pieces,  used  for  traffic  upon  the 
banks  of  the  Senegal,  or  the  somewhat  similar  pieces  circu- 
lated in  Abyssinia,  the  Soulou  Archipelago,  Sumatra,  Mex- 
ico, Peru,  Siberia,  and  among  the  Veddahs.  It  is  less  easy  to 
understand  the  origin  of  the  curious  straw  money  which  cir- 
culated until  1694  in  the  Portuguese  possessions  in  Angola, 
and  which  consisted  of  small  mats,  called  libongos,  woven  out 


1 6  THE  EARLY  HISTORY  OF  MONEY 

of  rice  straw,  and  worth  about  il/>d.  each.  These  mats  must 
have  had,  at  least  originally,  some  purpose  apart  from  their 
use  as  currency,  and  were  perhaps  analogous  to  the  fine  woven 
mats  so  much  valued  by  the  Samoans,  and  also  treated  by 
them  as  a  medium  of  exchange. 

Salt  has  been  circulated  not  only  in  Abyssinia,  but  in  Su- 
matra, Mexico,  and  elsewhere.  Cubes  of  benzoin  gum  or  bees- 
wax in  Sumatra,  red  feathers  in  the  Islands  of  the  Pacific 
Ocean,  cubes  of  tea  in  Tartary,  iron  shovels  or  hoes  among 
the  Malagasy,  are  other  peculiar  forms  of  currency.  The 
remarks  of  Adam  Smith  concerning  the  use  of  hand-made 
nails  as  money  in  some  Scotch  villages  will  be  remembered  by 
many  readers,  and  need  not  be  repeated.  M.  Chevalier  has 
adduced  an  exactly  corresponding  case  from  one  of  the  French 
coalfields. 

Were  space  available  it  would  be  interesting  to  discuss  the 
not  improbable  suggestion  of  Boucher  de  Perthes,  that,  per- 
haps, after  all,  the  finely  worked  stone  implements  now  so 
frequently  discovered  were  among  the  earliest  mediums  of 
exchange.  Some  of  them  are  certainly  made  of  jade,  nephrite, 
or  other  hard  stones,  only  found  in  distant  countries,  so  that 
an  active  traffic  in  such  implements  must  have  existed  in  times 
of  which  we  have  no  records  whatever. 

There  are  some  obscure  allusions  in  classical  authors  to  a 
wooden  money  circulating  among  the  Byzantines,  and  to  a 
wooden  talent  used  at  Antioch  and  Alexandria,  but  in  the 
absence  of  fuller  information  as  to  their  nature,  it  is  im- 
possible to  do  more  than  mention  them.  .  .  . 

THE  INVENTION  OF  COINING 

The  date  of  the  invention  of  coining  can  be  assigned  with 
some  degree  of  probability.  Coined  money  was  clearly  un- 
known in  the  Homeric-  times,  and  it  was  known  in  the  time 
of  Lycurgus.  We  might  therefore  assume,  with  various  au- 
thorities, that  it  was  invented  in  the  mean  time,  or  about 
900  B.  c.  There  is  tradition,  moreover,  that  Pheidon,  King 
of  Argos,  first  struck  silver  money  in  the  island  of  ^gina 
about  895  B.  c.,  and  the  tradition  is  supported  by  the  exist- 
ence of  small  stamped  ingots  of  silver,  which  have  been  found 


INVENTION  OF  COINAGE  17 

in  ^gina.  Later  inquiries,  however,  lead  to  the  conclusion 
that  Pheidon  lived  in  the  middle  of  the  eighth  century  B.  c., 
and  Grote  has  shown  good  reasons  for  believing  that  what  he 
did  accomplish  was  done  in  Argos,  and  not  in  y£gina. 

The  mode  in  which  the  invention  happened  is  sufficiently 
evident.  Seals  were  familiarly  employed  in  very  early  times, 
as  we  learn  from  the  Egyptian  paintings  or  the  stamped  bricks 
of  Nineveh.  Being  employed  to  signify  possession,  or  to 
ratify  contracts,  they  came  to  indicate  authority.  When  a 
ruler  first  undertook  to  certify  the  weights  of  pieces  of  metal, 
he  naturally  employed  his  seal  to  make  the  fact  known,  just 
as,  at  Goldsmiths'  Hall,  a  small  punch  is  used  to  certify  the 
fineness  of  plate.  In  the  earliest  forms  of  coinage  there  were 
no  attempts  at  so  fashioning  the  metal  that  its  weight  could 
not  be  altered  without  destroying  the  stamp  or  design.  The 
earliest  coins  struck,  both  in  Lydia  and  in  the  Peloponnesus, 
were  stamped  on  one  side  only.  .  .  . 


CHAPTER  III 


1  MANY  recent  writers,  such  as  Huskisson,  MacCulloch, 
James  Mill,  Gamier,  Chevalier,  and  Walras,  have  satisfactorily 
described  the  qualities  which  should  be  possessed  by  the  ma- 
terial of  money.  Earlier  writers  seem,  however,  to  have 
understood  the  subject  almost  as  well.  .  .  .  Of  all  writers, 
M.  Chevalier  .  .  .  probably  gives  the  most  accurate  and 
full  account  of  the  properties  which  money  should  possess, 
and  I  shall  in  many  points  follow  his  views. 

The  prevailing  defect  in  the  treatment  of  the  subject  is  the 
failure  to  observe  that  money  requires  different  properties  as 
regards  different  functions.  To  decide  upon  the  best  material 
for  money  is  thus  a  problem  of  great  complexity,  because  we 
must  take  into  account  at  once  the  relative  importance  of  the 
several  functions  of  money,  the  degree  in  which  money  is 
employed  for  each  function,  and  the  importance  of  each  of 
the  physical  qualities  of  the  substance  with  respect  to  each 
function.  In  a  simple  state  of  industry  money  is  chiefly 
required  to  pass  about  between  buyers  and  sellers.  It  should, 
then,  be  conveniently  portable,  divisible  into  pieces  of  various 
size,  so  that  any  sum  may  readily  be  made  up,  and  easily  dis- 
tinguishable by  its  appearance,  or  by  the  design  impressed 
upon  it.  When  money,  however,  comes  to  serve,  as  it  will 
at  some  future  time,  almost  exclusively  as  a  measure  and 
standard  of  value,  the  system  of  exchange,  being  one  of  per- 
fected barter,  such  properties  become  a  matter  of  comparative 
indifference,  and  stability  of  value,  joined  perhaps  to  porta- 
bility, is  the  most  important  quality.  Before  venturing,  how- 
ever, to  discuss  such  complex  questions,  we  must  proceed  to  a 
preliminary  discussion  of  the  properties  in  question,  which 

1  W.  Stanley  Jevohs,  Money  and  the  Mechanism  of  Exchange,  pp.  29-39. 
D.  Appleton  &  Company,  New  York,  1902. 

18 


UTILITY  AND  VALUE  19 

may  thus  perhaps  be  enumerated  in  the  order  of  their  im- 
portance : 

1.  Utility  and  value.  5.  Divisibility. 

2.  Portability.  6.  Stability  of  value. 

3.  Indestructibility.  7.  Cognisability. 

4.  Homogeneity. 

i.  UTILITY  AND  VALUE 

Since  money  has  to  be  exchanged  for  valuable  goods,  it 
should  itself  possess  value  and  it  must  therefore  have  utility 
as  the  basis  of  value.  Money,  when  once  in  full  currency,  is 
only  received  in  order  to  be  passed  on,  so  that  if  all  people 
could  be  induced  to  take  worthless  bits  of  material  at  a  fixed 
rate  of  valuation,  it  might  seem  that  money  does  not  really  re- 
quire to  have  substantial  value.  Something  like  this  does  fre- 
quently happen  in  the  history  of  currencies,  and  apparently 
valueless  shells,  bits  of  leather,  or  scraps  of  paper  are  actually 
received  in  exchange  for  costly  commodities.  This  strange 
phenomenon  is,  however,  in  most  cases  capable  of  easy  explana- 
tion, and  if  we  were  acquainted  with  the  history  of  every  kind 
of  money  the  like  explanation  would  no  doubt  be  possible  in 
other  cases.  The  essential  point  is  that  people  should  be  in- 
duced to  receive  money,  and  pass  it  on  freely  at  steady  ratios 
of  exchange  for  other  objects ;  but  there  must  always  be  some 
sufficient  reason  first  inducing  people  to  accept  the  money. 
The  force  of  habit,  convention,  or  legal  enactment  may  do  much 
to  maintain  money  in  circulation  when  once  it  is  afloat,  but  it  is 
doubtful  whether  the  most  powerful  government  could  oblige 
its  subjects  to  accept  and  circulate  as  money  a  worthless  sub- 
stance which  they  had  no  other  motive  for  receiving. 

Certainly,  in  the  early  stages  of  society,  the  use  of  money 
was  not  based  on  legal  regulations,  so  that  the  utility  of  the 
substance  for  other  purposes  must  have  been  the  prior  condi- 
tion of  its  employment  as  money.  Thus  the  singular  peag 
currency,  or  wampumpeag,  which  was  found  in  circulation 
among  the  North  American  Indians  by  the  early  explorers, 
was  esteemed  for  the  purpose  of  adornment,  as  already  men- 
tioned. .  .  .  The  cowry  shells,  so  widely  used  as  a  small 


20  QUALITIES  OF  THE  MATERIAL  OF  MONEY 

currency  in  the  East,  are  valued  for  ornamental  purposes  on 
the  West  Coast  of  Africa,  and  were  in  all  probability  em- 
ployed as  ornaments  before  they  were  employed  as  money. 
All  the  other  articles  [previously]  mentioned  .  .  .  such  as 
oxen,  corn,  skins,  tobacco,  salt,  cacao  nuts,  tea,  olive  oil,  etc., 
which  have  performed  the  functions  of  money  in  one  place  or 
another,  possessed  independent  utility  and  value.  If  there  are 
any  apparent  exceptions  at  all  to  this  rule,  they  would  doubt- 
less admit  of  explanation  by  fuller  knowledge.  We  may, 
therefore,  agree  with  Storch  when  he  says :  "  It  is  impossible 
that  a  substance  which  has  no  direct  value  should  be  introduced 
as  money,  however  suitable  it  may  be  in  other  respects  for 
this  use." 

When  once  a  substance  is  widely  employed  as  money,  it  is 
conceivable  that  its  utility  will  come  to  depend  mainly  upon 
the  services  which  it  thus  confers  upon  the  community.  Gold, 
for  instance,  is  far  more  important  as  the  material  of  money 
than  in  the  production  of  plate,  jewellery,  watches,  gold-leaf, 
etc.  A  substance  originally  used  for  many  purposes  may 
eventually  serve  only  as  money,  and  yet,  by  the  demand  for 
currency  and  the  force  of  habit,  may  maintain  its  value. 
The  cowry  circulation  of  the  Indian  coasts  is  probably  a  case 
in  point.  The  importance  of  habit,  personal  or  hereditary,  is 
at  least  as  great  in  monetary  science  as  it  is,  according  to  Mr. 
Herbert  Spencer,  in  morals  and  sociological  phenomena  gen- 
erally. 

There  is,  however,  no  reason  to  suppose  that  the  value  of 
gold  and  silver  is  at  present  due  solely  to  their  conventional 
use  as  money.  These  metals  are  endowed  with  such  singu- 
larly useful  properties  that,  if  we  could  only  get  them  in  suffi- 
cient abundance,  they  would  supplant  all  the  other  metals  in 
the  manufacture  of  household  utensils,  ornaments,  fittings  of 
all  kinds,  and  an  infinite  multitude  of  small  articles,  which  are 
now  made  of  brass,  copper,  bronze,  pewter,  German  silver,  or 
other  inferior  metals  and  alloys. 

In  order  that  money  may  perform  some  of  its  functions 
efficiently,  especially  those  of  a  medium  of  exchange  and  a 
store  of  value,  to  be  carried  about,  it  is  important  that  it 
should  be  made  of  a  substance  valued  highly  in  all  parts  of 


PORTABILITY  21 

the  world,  and,  if  possible,  almost  equally  esteemed  by  all 
peoples.  There  is  reason  to  think  that  gold  and  silver  have 
been  admired  and  valued  by  all  tribes  which  have  been  lucky 
enough  to  procure  them.  The  beautiful  lustre  of  these  metals 
must  have  drawn  attention  and  excited  admiration  as  much 
in  the  earliest  as  in  the  present  times. 

2.  PORTABILITY 

The  material  of  money  must  not  only  be  valuable,  but  the 
value  must  be  so  related  to  the  weight  and  bulk  of  the  ma- 
terial, that  the  money  shall  not  be  inconveniently  heavy  on  the 
one  hand,  nor  inconveniently  minute  on  the  other.  There  was 
a  tradition  in  Greece  that  Lycurgus  obliged  the  Lacedaemon- 
ians to  use  iron  money,  in  order  that  its  weight  might  deter 
them  from  overmuch  trading.  However  this  may  be,  it  is 
certain  .that  iron  money  could  not  be  used  in  cash  payments 
at  the  present  day,  since  a  penny  would  weigh  about  a  pound, 
and  instead  of  a  five-pound  note,  we  should  have  to  deliver  a 
ton  of  iron.  During  the  last  century  copper  was  actually 
used  as  the  chief  medium  of  exchange  in  Sweden;  and  mer- 
chants had  to  take  a  wheelbarrow  with  them  when  they  went 
to  receive  payments  in  copper  dalers.  Many  of  the  substances 
used  as  currency  in  former  times  must  have  been  sadly  want- 
ing in  portability.  Oxen  and  sheep,  indeed,  would  transport 
themselves  on  their  own  legs;  but  corn,  skins,  oil,  nuts, 
almonds,  etc.,  though  in  several  respects  forming  fair  currency, 
would  be  intolerably  bulky  and  troublesome  to  transfer. 

The  portability  of  money  is  an  important  quality  not 
merely  because  it  enables  the  owner  to  carry  small  sums  in 
the  pocket  without  trouble,  but  because  large  sums  can  be 
transferred  from  place  to  place,  or  from  continent  to  con- 
tinent, at  little  cost.  The  result  is  to  secure  an  approximate 
uniformity  in  the  value  of  money  in  all  parts  of  the  world.  A 
substance  which  is  very  heavy  and  bulky  in  proportion  to 
value,  like  corn  or  coal,  may  be  very  scarce  in  one  place  and 
over-abundant  in  another;  yet  the  supply  and  demand  can- 
not be  equalised  without  great  expense  in  carriage.  The  cost 
of  conveying  gold  or  silver  from  London  to  Paris,  including 
insurance,  is  only  about  four-tenths  of  one  per  cent.;  and 


22  QUALITIES  OF  THE  MATERIAL  OF  MONEY 

between  the  most  distant  parts  of  the  world  it  does  not  exceed 
from  2  to  3  per  cent. 

Substances  may  be  too  valuable  as  well  as  too  cheap,  so 
that  for  ordinary  transactions  it  would  be  necessary  to  call  in 
the  aid  of  the  microscope  and  the  chemical  balance.  Dia- 
monds, apart  from  other  objections,  would  be  far  too  valuable 
for  small  transactions.  The  value  of  such  stones  is  said  to 
vary  as  the  square  of  the  weight,  so  that  we  cannot  institute 
any  exact  comparison  with  metals  of  which  the  value  is  simply 
proportional  to  the  weight.  But  taking  a  one-carat  diamond 
(four  grains)  as  worth  £15,  we  find  it  is,  weight  for  weight, 
460  times  as  valuable  as  gold.  There  are  several  rare  metals, 
such  as  iridium  and  osmium,  which  would  likewise  be  far  too 
valuable  to  circulate.  Even  gold  and  silver  are  too  costly  for 
small  currency.  A  silver  penny  now  weighs  7)4  grains,  and 
a  gold  penny  would  weigh  only  half  a  grain.  The  pretty 
octagonal  quarter-dollar  tokens  circulated  in  California  are 
the  smallest  gold  coins  I  have  seen,  weighing  less  than  four 
grains  each,  and  are  so  thin  that  they  can  almost  be  blown 
away. 

3.  INDESTRUCTIBILITY 

If  it  is  to  be  passed  about  in  trade,  and  kept  in  reserve, 
money  must  not  be  subject  to  easy  deterioration  or  loss.  It 
must  not  evaporate  like  alcohol,  nor  putrefy  like  animal  sub- 
stances, nor  decay  like  wood,  nor  rust  like  iron.  Destructible 
articles,  such  as  eggs,  dried  codfish,  cattle,  or  oil,  have  cer- 
tainly been  used  as  currency ;  but  what  is  treated  as  money  one 
day  must  soon  afterwards  be  eaten  up.  Thus  a  large  stock 
of  such  perishable  commodities  cannot  be  kept  on  hand,  and 
their  value  must  be  very  variable.  The  several  kinds  of  corn 
are  less  subject  to  this  objection,  since,  when  well  dried  at 
first,  they  suffer  no  appreciable  deterioration  for  several  years. 

4.  HOMOGENEITY 

All  portions  of  specimens  of  the  substance  used  as  money 
should  be  homogeneous,  that  is,  of  the  same  quality,  so  that 
equal  weights  will  have  exactly  the  same  value.  In  order  that 
we  may  correctly  count  in  terms  of  any  unit,  the  units  must 


DIVISIBILITY  23 

de  equal  and  similar,  so  that  twice  two  will  always  make  four. 
If  we  were  to  count  in  precious  stones,  it  would  seldom  happen 
that  four  stones  would  be  just  twice  as  valuable  as  two  stones. 
Even  the  precious  metals,  as  found  in  the  native  state,  are  not 
perfectly  homogeneous,  being  mixed  together  in  almost  all 
proportions;  but  this  produces  little  inconvenience,  because 
the  assayer  readily  determines  the  quantity  of  each  pure 
metal  present  in  any  ingot.  In  the  processes  of  refining  and 
coining,  the  metals  are  afterwards  reduced  to  almost  exactly 
uniform  degrees  of  fineness,  so  that  equal  weights  are  then  of 
exactly  equal  value. 

5.  DIVISIBILITY 

Closely  connected  with  the  last  property  is  that  of  divisibil- 
ity. Every  material  is,  indeed,  mechanically  divisible,  almost 
without  limit.  The  hardest  gems  can  be  broken,  and  steel 
can  be  cut  by  harder  steel.  But  the  material  of  money  should 
be  not  merely  capable  of  division,  but  the  aggregate  value  of 
the  mass  after  division  should  be  almost  exactly  the  same  as 
before  division.  If  we  cut  up  a  skin  or  fur  the  pieces  will, 
as  a  general  rule,  be  far  less  valuable  than  the  whole  skin  or 
fur,  except  for  a  special  intended  purpose;  and  the  same  is 
the  case  with  timber,  stone,  and  most  other  materials  in  which 
reunion  is  impossible.  But  portions  of  metal  can  be  melted 
together  again  whenever  it  is  desirable,  and  the  cost  of  doing 
this,  including  the  metal  lost,  is  in  the  case  of  precious  metals 
very  inconsiderable,  varying  from  l/^d.  to  l/>d.  per  ounce. 
Thus,  approximately  speaking,  the  value  of  any  piece  of  gold 
or  silver  is  simply  proportional  to  the  weight  of  fine  metal 
which  it  contains. 

6.  STABILITY  OF  VALUE 

It  is  evidently  desirable  that  the  currency  should  not  be 
subject  to  fluctuations  of  value.  The  ratios  in  which  money 
exchanges  for  other  commodities  should  be  maintained  as 
nearly  as  possible  invariable  on  the  "average.  This  would  be 
a  matter  of  comparatively  minor  importance  were  money  used 
only  as  a  measure  of  values  at  any  one  moment,  and  as  a 
medium  of  exchange.  If  all  prices  were  altered  in  like  pro- 


24  QUALITIES  OF  THE  MATERIAL  OF  MONEY 

portion  as  soon  as  money  varied  in  value,  no  one  would  lose 
or  gain,  except  as  regards  the  coin  which  he  happened  to  have 
in  his  pocket,  safe,  or  bank  balance.  But,  practically  speak- 
ing, as  we  have  seen,  people  do  employ  money  as  a  standard 
of  value  for  long  contracts,  and  they  often  maintain  pay- 
ments at  the  same  variable  rate,  by  custom  or  law,  even  when 
the  real  value  of  the  payment  is  much  altered.  Hence  every 
change  in  the  value  of  money  does  some  injury  to  society. 

It  might  be  plausibly  said,  indeed,  that  the  debtor  gains  as 
much  as  the  creditor  loses,  or  vice  versa,  so  that  on  the  whole 
the  community  is  as  rich  as  before ;  but  this  is  not  really  true. 
A  mathematical  analysis  of  the  subject  shows  that  to  take  any 
sum  of  money  from  one  and  give  it  to  another  will,  on  the 
average  of  cases,  injure  the  loser  more  than  it  benefits  the 
receiver^  A  person  with  an  income  of  one  hundred  pounds 
a  year  would  suffer  more  by  losing  ten  pounds  than  he  would 
gain  by  an  addition  of  ten  pounds,  because  the  degree  of 
utility  of  money  to  him  is  considerably  higher  at  ninety  pounds 
than  it  is  at  one  hundred  and  ten.  On  the  same  principle,  all 
gaming,  betting,  pure  speculation,  or  other  accidental  modes 
of  transferring  property  involve,  on  the  average,  a  dead  loss 
of  utility.  The  whole  incitement  to  industry  and  commerce 
and  the  accumulation  of  capital  depends  upon  the  expecta- 
tion of  enjoyment  thence  arising,  and  every  variation  of  the 
currency  tends  in  some  degree  to  frustrate  such  expectation 
and  to  lessen  the  motives  for  exertion. 

7.    COGNIZABILITY 

By  this  name  we  may  denote  the  capability  of  a  substance 
for  being  easily  recognised  and  distinguished  from  all  other 
substances.  As  a  medium  of  exchange,  money  has  to  be  con- 
tinually handed  about,  and  it  will  occasion  great  trouble  if 
every  person  receiving  currency  has  to  scrutinize,  weigh,  and 
test  it.  If  it  requires  any  skill  to  discriminate  good  money 
from  bad,  poor  ignorant  people  are  sure  to  be  imposed  upon. 
Hence  the  medium  of  exchange  should  have  certain  distinct 
marks  which  nobody  can  mistake.  Precious  stones,  even  if 
in  other  respects  good  as  money,  could  not  be  so  used,  because 


COGNIZABILITY  25 

only  a  skilled  lapidary  can  surely  distinguish  between  true  and 
imitation  gems. 

Under  cognisability  we  may  properly  include  what  has  been 
aptly  called  impressibility,  namely,  the  capability  of  a  sub- 
stance to  receive  such  an  impression,  seal,  or  design,  as  shall 
establish  its  character  as  current  money  of  certain  value.  We 
might  more  simply  say,  that  the  material  of  money  should  be 
coinable,  so  that  a  portion,  being  once  issued  according  to 
proper  regulations  with  the  impress  of  the  state,  may  be  known 
to  all  as  good  and  legal  currency,  equal  in  weight,  size,  and 
value  to  all  similarly  marked  currency.  .  .  . 


CHAPTER  IV 
LEGAL  TENDER1 

THE  essential  idea  of  "  legal  tender  "  is  that  quality  given 
to  money  by  law  which  obliges  the  creditor  to  receive  it  in  full 
satisfaction  of  a  past  debt  when  expressed  in  general  terms  of 
the  money  of  a  country.  A  debt  is  a  sum  of  money  due  by 
contract,  express  or  implied.  When  our  laws,  for  instance, 
declare  that  United  States  notes  are  legal  tender  —  and  this  is 
the  only  complete  designation  of  a  legal-tender  money  —  for 
"  all  debts  public  and  private,"  it  must  be  understood  that  this 
provision  does  not  cover  any  operations  not  arising  from 
contract.  Current  buying  and  selling  do  not  make  a  situation 
calling  for  legal  tender ;  a  purchaser  cannot  compel  the  delivery 
of  goods  over  a  counter  by  offering  legal-tender  money  for 
them,  because,  as  yet,  no  debt  has  been  created.2 

Contracts  made  in  general  terms  of  the  money  units  of  the 
country  must  necessarily  often  be  interpreted  by  the  courts. 
The  existence  of  contracts  calling  for  a  given  sum  of  dollars 
and  the  necessity  of  adjudicating  and  enforcing  such  contracts, 
require  that  there  should  be  an  accurate  legal  interpretation 
of  what  a  dollar  is.  As  every  one  knows,  the  name,  or  unit 
of  account,  is  affixed  to  a  given  number  of  grains  of  a  specified 
fineness  of  a  certain  metal.  This  being  the  standard,  and  this 
having  been  chosen  by  the  concurring  habits  of  the  business 
world,  it  is  fit  that  the  law  should  designate  that,  when  only 

1  Report  of  the  Monetary  Commission  of  the  Indianapolis  Convention, 
pp.  131-7.  The  Hollenbeck  Press,  Indianapolis,  1900. 

2 "  A  contract  payable  in  money  generally  is,  undoubtedly,  payable  in 
any  kind  of  money  made  by  law  legal  tender,  at  the  option  of  the  debtor 
at  the  time  of  payment.  He  contracts  simply  to  pay  so  much  money,  and 
creates  a  debt  pure  and  simple;  and  by  paying  what  the  law  says  is  money 
his  contract  is  performed.  But,  if  he  agrees  to  pay  in  gold  coin,  it  is  not 
an  agreement  to  pay  money  simply,  but  to  pay  or  deliver  a  specific  kind  of 
money,  and  nothing  else ;  and  the  payment  in  any  other  is  not  a  ful- 
filment of  the  contract  according  to  its  terms  or  the  intention  of  the  par- 
lies/' 25  California  564,  Carpenter  vs.  Atherton. 

26 


THE  SOLE  STANDARD  27 

dollars  are  mentioned  in  a  contract,  it  should  be  satisfied  only 
by  the  payment  of  that  which  is  the  standard  money  of  the 
community. 

Since  prices  and  contracts  are  expressed  in  terms  of  the 
standard  article,  it  is  clear  that  the  legal-tender  quality  should 
not  be  equally  affixed  to  different  articles  having  different 
values,  but  called  by  the  same  name.  This  method  would  be 
sure  to  bring  confusion,  uncertainty,  and  injustice  into  trade 
and  industry.  No  one  who  had  made  a  contract  would  know 
in  what  he  was  to  be  paid.  The  legal-tender  quality,  then, 
should  be  confined  to  that  which  is  the  sole  standard.  And  it 
is  also  obvious  that  when  a  standard  is  satisfactorily  de- 
termined upon,  and  when  various  effective  media  of  exchange, 
like  bank  notes,  checks,  or  bills  of  exchange,  have  sprung  up, 
the  legal-tender  quality  should  not  be  given  to  these  instru- 
ments of  convenience.  They  are  themselves  expressed  in, 
and  are  resolvable  into,  the  standard  metal;  so  the  power  to 
satisfy  debts  should  be  given  not  to  the  shadow,  but  to  the 
substance,  not  to  the  devices  drawn  in  terms  of  the  standard, 
but  only  to  the  standard  itself,  even  though,  as  a  matter  of 
fact,  nine-tenths  of  the  debts  and  contracts  are  actually  settled 
by  means  of  these  devices.  So  long  as  these  instruments  are 
convertible  into,  and  thus  made  fully  equal  to,  the  standard  in 
terms  of  which  they  are  drawn,  they  will  be  used  by  the  busi- 
ness community  for  the  settlement  of  debts  without  being 
made  a  legal  tender."  And  whenever  they  are  worth  less  than 
the  standard  they  certainly  should  not  be  made  a  legal  tender, 
because  of  the  injustice  which  in  such  a  case  they  would  work. 

Having  shown  that  the  legal-tender  quality  is  only  a  neces- 
sary legal  complement  of  the  choice  of  a  standard,  it  will  not 
be  difficult  to  see  that  the  state  properly  chooses  an  article  fit 
to  have  the  legal-tender  attribute  for  exactly  the  reasons  that 
governed  the  selection  of  the  same  article  as  a  standard.  The 
whole  history  of  money  shows  that  the  standard  article  was  the 
one  which  had  utility  to  the  community  using  it.  As  the  evolu- 
tion of  the  money  commodity  went  on  from  cattle  to  silver  and 
gold,  so  the  legal-tender  provisions  naturally  followed  this 
course. 

A  state  may  select  a  valueless  commodity  as  a  standard, 


28  LEGAL  TENDER 

but  that  will  not  make  it  of  value  to  those  who  would  already 
give  nothing  for  it ;  and  so,  it  may  give  the  legal-tender  quality 
to  a  thing  which  has  become  valueless,  but  that  will  not  of  itself 
insure  the  maintenance  of  its  former  value.  This  proposition 
may,  at  first,  appear  to  be  opposed  to  a  widely-spread  belief; 
but  its  soundness  can  be  fully  supported.  It  should  be  learned 
that  a  commodity,  or  a  standard,  holds  its  value  for  reasons 
quite  independent  of  the  fact  that  it  is  given  legal  recognition. 
It  has  happened  that  legal  recognition  has  been  given  to  it  be- 
cause it  possessed  qualities  that  gave  it  value  to  the  commercial 
world,  and  not  that  it  came  to  have  these  qualities  and  this 
value  because  it  was  made  a  legal  tender. 

A  good  illustration  of  this  truth  is  to  be  found  in  interna- 
tional trade.  Money  which  is  not  dependent  on  artificial  influ- 
ences for  its  value,  and  which  is  not  redeemable  in  something 
else,  is  good  the  world  over  at  its  actual  commercial  value,  not 
at  its  value  as  fixed  by  any  legal-tender  laws.  It  is  not  the 
legal-tender  stamp  that  gives  a  coin  its  value  in  international 
payments.  A  sovereign,  an  eagle,  a  napoleon,  is  constantly 
given  and  received  in  international  trade  not  because  of  the 
stamp  it  bears,  but  because  of  the  number  of  grains  of  a  given 
fineness  of  gold  which  it  contains  —  the  value  of  which  is  de- 
termined in  the  markets  of  the  world.  And  an  enormous  trade 
among  the  great  commercial  countries  goes  on  easily  and  ef- 
fectively without  regard  to  the  legal-tender  laws  of  the  partic- 
ular country  whose  coins  are  used. 

By  imposing  the  attribute  of  legal  tender,  however,  upon  a 
given  metal  or  money,  it  may  be  believed  that  thereby  a  new 
demand  is  created  for  that  metal,  and  that  its  value  is  thus 
controlled.  And  in  theory  there  is  some  basis  for  this  belief. 
It  is,  of  course,  true  that,  in  so  far  as  giving  to  money  a  legal- 
tender  power  creates  a  new  demand  for  it  (which  without  that 
power  would  not  have  existed)  an  effect  upon  its  value  can  be 
produced.  But  this  effect  is  undoubtedly  much  less  than  is 
usually  supposed.  It  must  be  remembered  that  the  value  of 
gold,  for  instance,  is  affected  by  world  influences ;  that  its  value 
is  determined  by  the  demand  of  the  whole  world  as  compared 
with  the  whole  existing  supply  in  the  world.  In  order  to 
affect  the  value  of  gold  in  any  one  country,  a  demand  created 


LEGAL  TENDER  AND  VALUE  29 

by  a  legal-tender  enactment  must  be  sufficient  to  affect  the 
world-value  of  gold.  Evidently  the  effect  will  be  only  in  the 
proportion  that  the  new  demand  bears  to  the  whole  stock  in 
the  world.  It  is  like  the  addition  of  a  barrel  of  water  to  a 
pond;  theoretically  the  surface  level  is  raised,  but  not  to  any 
appreciable  extent. 

It  may  now  be  permissible  to  examine  into  the  extent  to 
which  a  demand  is  created  by  legal-tender  laws.  If  the  article 
endowed  with  a  legal-tender  power  is  already  used  as  the 
standard  and  as  a  medium  of  exchange,  it  is  given  no  value 
which  it  did  not  have  before.  The  customs  and  business  habits 
of  a  country  alone  determine  how  much  of  the  standard  coin 
will  be  carried  about  and  used  in  hand-to-hand  purchases,  and 
how  much  of  the  business  will  be  performed  by  other  media 
of  exchange,  such  as  checks  or  drafts.  The  decision  of  a 
country  to  adopt  gold  —  when  it  had  only  paper  before,  as 
was  the  case  in  Italy  —  would  create  a  demand  for  gold  to  an 
extent  determined  by  the  monetary  habits  of  that  country ;  and 
this  demand  has  an  effect,  as  was  said,  only  in  the  proportion 
of  this  amount  to  the  total  supply  in  the  world.  This  opera- 
tion arises  from  choosing  gold  as  the  standard  of  prices  and 
as  the  medium  of  exchange.  To  give  this  standard  a  legal- 
tender  power  in  addition  does  not  increase  the  demand  for 
it,  because  the  stamp  on  the  coin  does  not  in  any  way  alter  the 
existing  habits  of  the  community  as  to  the  quantity  of  money 
it  will  use. 

But  in  case  an  equal  power  to  pay  debts  is  given  to  fixed 
quantities  of  two  metals,  while  each  quantity  so  fixed  has  a 
different  metallic  value  but  the  same  denomination  in  the 
coinage,  Gresham's  law  is  set  in  operation  with  the  result  that 
the  cheaper  metal  becomes  the  standard.  After  this  change 
has  been  accomplished,  the  legal  tender  has  no  value-giving 
force.  When  the  cheaper  metal  has  become  the  standard,  its 
legal-tender  quality  does  not  raise  the  value  of  the  coin  beyond 
the  value  of  its  content.  This  cheaper  standard,  in  interna- 
tional trade,  would  be  worth  no  more  in  the  purchase  of 
goods  because  it  bore  the  stamp  of  any  one  country.  Prices 
must  necessarily  be  adjusted  between  the  relative  values  of 
goods  and  the  standard  with  which  they  are  compared.  If  the 


'30  LEGAL  TENDER 

standard  is  cheaper,  prices  will  be  higher,  irrespective  of  legal- 
tender  acts.  Where  two  metals  are  concerned,  then,  the 
only  effect  of  a  legal-tender  clause  is  an  injurious  one,  in  that 
the  metal  which  is  overvalued  drives  out  that  which  is  under- 
valued. 

The  example  of  an  inconvertible  paper,  such  as  our  United 
States  notes  (greenbacks)  in  1862-1879,  is  still  more  con- 
clusive. Although  a  full  legal  tender  for  all  debts  public  and 
private,  their  value  steadily  sank  until  they  were  at  one  time 
worth  only  35  cents  in  gold.  In  California,  moreover,  these 
notes,  although  legal-tender,  were  even  kept  out  of  circulation 
by  public  opinion.  In  short,  the  value  of  inconvertible  paper 
can  be  but  little  affected  by  legal-tender  powers.  Its  value  is 
more  directly  governed,  as  in  the  case  of  token  coins,  by  the 
probabilities  of  redemption.1  As  bearing  on  the  point  that 
the  value  of  the  paper  was  more  influenced  by  the  chances  of 
redemption  than  by  legal-tender  laws,  we  may  cite  the  sudden 
fluctuations  in  the  value  of  our  United  States  notes  during  the 
Civil  War.  With  no  change  in  the  legal-tender  quality  and  no 
change  in  the  indebtedness  which  .might  be  paid  with  such 
notes,  their  value  frequently  rose  or  fell  many  per  cent,  in  a 
single  day  owing  to  reports  of  Federal  successes  or  defeats 
in  battle,  which  had  a  tendency  to  affect  one  way  or  the  other 
the  public  estimate  of  the  probabilities  of  an  early  resumption 
of  specie  payments.  The  fact  that  they  were  legal  tender  evi- 
dently had  no  effect  whatever  in  maintaining  their  value. 

In  view  of  the  evident  fact  that  legal-tender  acts  do  not 
preserve  the  value  of  money,  it  is  clear  that  the  demand  cre- 
ated by  such  legislation  must  be  insignificant.  And  this  must 
be  so  in  principle  as  well  as  in  fact. 

There  is  but  one  thing  which  the  legal-tender  quality  en- 
ables money  to  do  which  it  could  not  equally  well  do  without 
being  a  legal  tender ;  that  is,  to  pay  past  debts.  An  examina- 
tion, however,  shows  that  this  use  of  money  is  very  small 
compared  with  its  other  uses.  The  amount  of  past  debts  com- 
ing due  and  which  might  be  paid  in  any  year,  month  or  day  is 
insignificant  when  compared  with  the  total  transactions  of  that 

1  For  a  contrary  view,  see  Joseph   French  Johnson,  Money  and  Cur- 
rency, Chapter  13. —  EDITOR. 


LEGAL  TENDER  AND  PAST  DEBTS  31 

year,  month  or  day  —  so  very  small  as  to  lose  all  measurable 
value-giving  power.  In  other  words,  the  one  thing  which 
legal-tender  money  can  surely  do  in  spite  of  the  habits,  wishes 
or  prejudices  of  the  business  community  in  which  it  exists, 
namely,  cancel  past  debt,  is  infinitesimally  small  when  com- 
pared with  those  other  things  which  man  wishes  money  to  do 
for  him.  It  is  for  this  reason  that  it  ceases  to  give  value,  and 
this  is  why  history  has  shown  so  many  instances  where  money 
endowed  with  legal-tender  power  has  become  utterly  value- 
less. The  legal-tender  money  is  no  longer  money  if  it  will  not 
secure  for  man  the  things  which  are  most  important  for  his 
welfare,  if  it  will  not  buy  food,  clothes  and  shelter;  for  it 
performs  none  of  the  functions  of  money  except  the  subsidiary 
one  of  cancelling  past  debts. 

Moreover,  the  obligatory  uses  of  legal-tender  money  are  in 
fact  very  inconsiderable.  A  law  requiring  a  past  debt  to  be 
satisfied  with  money  of  a  certain  kind  has  for  its  essence  only 
the  payment  of  something  of  a  definite  value,  or  its  equiva- 
lent; in  practice,  it  does  not  even  bring  about  the  actual  use 
of  a  legal  money,  since  the  monetary  habits  of  the  community 
will  not  necessarily  require  the  debt  to  be  paid  in  such  money. 
Take  the  extreme  case  of  a  judgment  by  a  court  against  a 
defendant  for  fulfilment  of  a  contract;  in  such  an  example, 
of  all  others,  it  would  be  supposed  that  legal  money  would  be 
exacted.  But  even  here,  the  judgment  would  most  probably 
be  satisfied  by  the  attorney's  check,  or  at  most  by  a  certified 
check.  If  such  media  of  exchange  are  of  common  usage  in 
the  community  they  will  be  resorted  to  in  practice  even  for 
legal-tender  payments. 

The  necessity  of  paying  that  which  would  be  mutually 
satisfactory  to  payer  and  payee  also  makes  clear  why  the 
existence  of  a  legal-tender  money  does  not  necessarily  cause 
its  actual  use  in  payments.  The  business  habits  of  the  com- 
munity are  stronger  than  legislative  powers.  Business  men 
will  not  as  a  rule  take  advantage  of  a  legal-tender  act  to  pay 
debts  in  a  cheaper  money,  if  they  look  forward  to  remaining 
in  business.  For,  if,  by  taking  advantage  of  legal  devices 
they  defraud  the  creditor,  they  cannot  expect  credit  again  from 
the  same  source;  and  since  loans  are  a  necessity  of  legitimate 


32  LEGAL  TENDER 

modern  trade,  such  action  would  ruin  their  credit  and  cut 
them  off  from  business  activity  in  the  future.  Gold  was  not 
driven  out  of  circulation  by  paper  money  during  the  years 
1862-1879  in  California,  because  the  sentiment  of  the  busi- 
ness public  was  against  the  use  of  our  depreciated  greenback 
currency;  and  a  discrimination  was  made  against  merchants 
who  resorted  to  the  use  of  paper. 

Explanation  has  been  given  of  the  principles  according  to 
which  legal-tender  laws  should  be  applied,  if  at  all.  It  is  not 
wholly  clear  that  there  is  any  reason  for  their  existence.  It 
may  now  be  well  to  indicate  briefly  the  origin  of  legal-tender 
provisions.  It  can  scarcely  be  doubted  that  their  use  arose 
from  the  desire  of  defaulting  monarchs  to  ease  their  indebted- 
ness by  forcing  upon  creditors  a  debased  coinage.  Having 
possession  of  the  mints,  the  right  of  coinage  vesting  in  the 
lord,  the  rulers  of  previous  centuries  have  covered  the  pages  of 
history  with  the  records  of  successive  debasements  of  the 
money  of  account.  The  le'gal-tender  enactment  was  the  in- 
strument by  which  the  full  payment  of  debts  was  evaded. 
There  would  have  been  no  reason  for  debasing  coins,  if  they 
could  not  be  forced  upon  unwilling  creditors.  It  is,  therefore, 
strange  indeed  that,  in  imitation  of  monarchical  morals  of 
a  past  day,  republican  countries  should  have  thought  it  a  wise 
policy  to  clothe  depreciated  money  with  a  nominal  value  for 
paying  debts.  Although  the  people  are  now  sovereign,  they 
should  not  embrace  the  vices  of  mediaeval  sovereignty  for  their 
own  dishonest  gain  in  scaling  debts. 


CHAPTER  V 
THE  GREENBACKS 

THE  GREENBACK  ISSUES 

1  THE  greenbacks  were  an  outgrowth  of  the  Civil  War. 
Soon  after  the  opening  of  the  struggle  the  Secretary  of  the 
Treasury  negotiated  a  loan  of  $150,000,000  with  Eastern 
banks.  Partly  because  of  Confederate  successes  and  partly 
because  of  the  failure  of  Secretary  Chase  to  adopt  a  firm 
policy  of  loans  supported  by  taxation,  public  credit  greatly  de- 
clined, and  Government  bonds  became  almost  unsaleable.  The 
outlook  became  alarming  and  depositors  withdrew  gold  from 
the  New  York  banks  in  such  large  amounts  that  specie  pay- 
ments were  suspended,  December  30,  1861.  In  February, 
1862,  Congress  provided  for  the  issue  of  $150,000,000  in 
United  States  notes  or  greenbacks.  Bond  sales  proceeded 
slowly  and  a  second  issue  of  $150,000,000  of  notes  was  au- 
thorised in  July  of  the  same  year.  As  a  result  of  "  military 
necessity  "  a  third  issue  of  $100,000,000  was  authorised  Janu- 
ary 17,  1863,  and  temporarily  increased  March  3  to  $150,- 
000,000.  Provision  was  made  for  the  reissue  of  the  green- 
backs and  $400,000,000  were  outstanding  at  the  close  of  the 
war. 

THE  FLUCTUATING  PREMIUM  ON  GOLD 

Depreciation  of  the  greenbacks  occurred  at  once  and  the 
value  of  gold  as  expressed  in  greenbacks  was  subject  to  almost 
constant  change.  During  the  year  1862  the  premium  varied 
from  2  to  32;  in  1863  from  25  to  60;  and  in  1864  from 
55  to  185.  Among  the  most  important  political  and  economic 
factors  which  caused  these  fluctuations  may  be  mentioned : 

1  Adapted  from  Wesley  Clair  Mitchell,  A  History  of  the  Greenbacks, 
Part  II,  The  University  of  Chicago  Press,  1903. 

33 


34  THE  GREENBACKS 

(1)  The  increase  in  the  amount  of  the  greenbacks.     Each 
new  issue  was  reflected  in  a  rise  in  the  premium. 

(2)  The  condition  of  the  treasury.     The  annual  reports  of 
the  Secretary  of  the  Treasury  were  anxiously  awaited  and 
their  appearance  caused  a  rise  or  fall  of  the  premium  accord- 
ing as  the  condition  of  the  finances  seemed  gloomy  or  hopeful. 

(3)  Ability  of  the  Government  to  borrow.     The  fate  of  a 
loan  indicated  public  confidence  or  distrust. 

(4)  Changes  in  the  officials  of  the  treasury  department. 
Secretary  Chase's  resignation,   July    I,    1864,   depressed  the 
currency  decidedly. 

(5)  War  news.     Every  victory  raised  the  price  of  cur- 
rency and  every  defeat  depressed  it. 

From  1862  to  1865  the  premium  on  gold  and  the  median 
of  relative  prices  correspond  so  well  that  one  Cannot  resist  the 
conclusion  that  these  changes  were  mainly  due  to  a  common 
cause,  which  can  hardly  be  other  than  the  varying  esteem  in 
which  the  notes  of  the  Government  that  constituted  the  stand- 
ard money  of  the  country  were  held.  If  this  conclusion  be  ac- 
cepted, it  follows  that  the  suspension  of  specie  payments  and 
the  legal-tender  acts  must  be  held  almost  entirely  responsible 
for  all  the  far-reaching  economic  disturbances  following  from 
the  price  upheaval  which  it  is  our  task  now  to  trace  in  detail. 

THE  EFFECTS  OF  GREENBACKS  UPON  WAGES 

Statistical  evidence  supports  unequivocally  the  common 
theory  that  persons  whose  incomes  are  derived  from  wages 
suffer  seriously  from  a  depreciation  of  the  currency.  The 
confirmation  seems  particularly  striking  when  the  conditions 
other  than  monetary  affecting  the  labour  market  are  taken  into 
consideration.  American  workingmen  are  intelligent  and 
keenly  alive  to  their  interests.  There  are  probably  few  dis- 
tricts where  custom  plays  a  smaller  and  competition  a  larger 
role  in  determining  wages  than  in  the  Northern  States.  While 
labor  organisations  had  not  yet  attained  their  present  power, 
manual  laborers  did  not  fail  to  avail  themselves  of  the  help 
of  concerted  action  in  the  attempt  to  secure  more  pay.  Strikes 
were  frequent.  All  these  facts  favored  a  speedy  readjust- 
ment of  money  wages  to  correspond  with  changed  prices. 


EFFECTS  UPON  WAGES  35 

But  more  than  all  else,  a  very  considerable  part  of  the  labor 
supply  was  withdrawn  from  the  market  into  the  army  and 
navy.  In  1864  and  1865  about  one  million  of  men  seem  to 
have  been  enrolled.  About  one-seventh  of  the  labor  supply 
withdrew  from  the  market.  But  despite  all  these  favoring 
circumstances,  the  men  who  stayed  at  home  did  not  succeed  in 
obtaining  an  advance  in  pay  at  all  commensurate  with  the  in- 
crease in  living  expenses.  Women  on  the  whole  succeeded 
less  well  than  men  in  the  struggle  to  readjust  money  wages  to 
the  increased  cost  of  living. 

It  is  sometimes  argued  that  the  withdrawal  of  laborers 
from  industrial  life  was  the  chief  cause  of  the  price  disturb- 
ances of  the  war  period.  This  withdrawal,  it  is  said,  caused 
the  advance  of  wages,  and  greater  cost  of  labor  led  to  the 
rise  of  prices.  The  baselessness  of  this  view  is  shown  by  two 
well  established  facts  —  first,  that  the  advance  of  wages  was 
later  than  the  advance  of  prices,  and  second,  that  wages  con- 
tinued to  rise  in  1866  after  the  volunteer  armies  had  been  dis- 
banded and  the  men  gone  back  to  work. 

Wage-earners,  however,  seem  to  have  been  more  fully  em- 
ployed during  the  war  than  in  common  times  of  prosperity. 
Of  course,  the  enlistment  of  so  many  thousands  of  the  most 
efficient  workers  made  places  for  many  who  might  otherwise 
have  found  it  difficult  to  secure  work.  Moreover,  the  paper 
currency  itself  tended  to  obtain  full  employment  for  the 
laborer,  for  the  very  reason  that  it  diminished  his  real  in- 
come. In  the  distribution  of  what  Marshall  has  termed  the 
"  national  dividend  "  a  diminution  of  the  proportion  received 
by  the  laborer  must  have  been  accompanied  by  an  increase  in 
the  share  of  some  one  else.  Nor  is  it  difficult  to  determine 
who  this  person  was.  The  beneficiary  was  the  active  employer, 
who  found  that  the  money  wages,  interest,  and  rent  he  had  to 
pay  increased  less  rapidly  than  the  money  prices  of  his  prod- 
ucts. The  difference  between  the  increase  of  receipts  and  the 
increase  of  expenses  swelled  his  profits.  Of  course,  the  possi- 
bility of  making  high  profits  provided  an  incentive  for  employ- 
ing as  many  hands  as  possible. 

After  an  examination  of  the  change  in  the  condition  of  the 
great  mass  of  wage-earners,  it  may  seem  surprising  that  few 


36  THE  GREENBACKS 

complaints  were  heard  from  them  of  unusual  privations.  This 
silence  may  be  due  in  part  to  the  fact  that  a  considerable  in- 
crease of  money  income  produces  in  the  minds  of  many  a 
fatuous  feeling  of  prosperity,  even  though  it  be  more  than 
offset  by  an  increase  of  prices.  But  doubtless  the  chief  reason 
is  to  be  found  in  the  absorption  of  public  interest  in  the  events 
of  the  war.  The  people  both  of  the  South  and  North  were  so 
vitally  concerned  with  the  struggle  that  they  bore  without 
murmuring  the  hardships  it  entailed  of  whatever  kind.  Gov- 
ernment taxation  that  under  other  circumstances  might  have 
been  felt  to  be  intolerable  was  submitted  to  with  cheerfulness. 
The  paper  currency  imposed  upon  wage-earners  a  heavier  tax 
— •  amounting  to  confiscation  of  perhaps  a  fifth  or  a  sixth  of 
real  incomes.  But  the  workingmen  of  the  North  were  receiv- 
ing considerably  more  than  a  bare  subsistence  minimum  before 
the  war,  and  reduction  of  consumption  was  possible  without 
producing  serious  want.  Accordingly  the  currency  tax,  like 
the  tariff  and  the  internal  revenue  duties,  was  accepted  as  a 
necessary  sacrifice  to  the  common  cause  and  paid  without 
protest  by  severe  retrenchment. 

RENT 
URBAN  RENTS 

In  studying  the  influence  of  depreciation  upon  rent,  it  is 
necessary  to  use  that  term  in  its  popular  rather  than  in  its 
scientific  sense.  This  fact  is  less  to  be  lamented,  because  the 
theorist  himself  admits  that  the  distinction  becomes  sadly 
blurred  when  he  attempts  to  deal  with  short  intervals  of  time. 
Capital  once  invested  in  improvements  can  seldom  be  with- 
drawn rapidly.  In  "  the  short  run,"  therefore,  it  is  practically 
a  part  of  the  land,  and  the  return  to  it  follows  the  analogy  of 
rent  rather  than  of  interest. 

The  renting  landlord  found  that  the  degree  in  which  he  was 
affected  by  the  fluctuations  in  the  value  of  the  paper  money 
depended  largely  upon  the  terms  of  the  contract  into  which 
he  had  entered.  It  is  clear  from  a  careful  examination  that 
the  landlord  who  before  suspension  had  leased  his  property 
for  a  considerable  period  without  opportunity  for  revaluation 


EFFECTS  UPON  RENT  37 

must  have  suffered  severely  if  paid  in  greenbacks.  The  num- 
ber of  "dollars  "  received  as  rental  might  be  the  same  in  1865 
as  in  1860,  but  their  purchasing  power  was  less  than  one-half 
as  great.  Somewhat  less  hard  was  the  situation  of  the  land- 
lord who  had  let  his  property  for  but  one  or  two  years.  At  the 
expiration  of  the  leases  he  had  opportunities  to  make  new 
contracts  with  the  tenants. 

In  his  capacity  as  special  commissioner  of  the  revenue,  Mr. 
David  A.  Wells  devoted  some  attention  to  the  rise  of  vent. 
His  report  for  December,  1866,  says: 

The  average  advance  in  the  rents  of  houses  occupied  by  mechanics 
and  laborers  in  the  great  manufacturing  centres  of  the  country  is 
estimated  to  have  been  about  90  per  cent. ;  in  some  sections,  how- 
ever, a  much  greater  advance  has  been  experienced,  as  for  example, 
at  Pittsburgh,  where  200  per  cent,  and  upward  is  reported.  In  many 
of  the  rural  districts,  on  the  other  hand,  the  advance  has  been  much 
less.  Mr.  Wells  later  modified  this  estimate  somewhat. 

The  advance  in  rents  was  greater  in  cities  than  in  minor 
towns.  In  some  cities  —  e.  g.,  Cincinnati  and  Louisville  — 
owners  of  workingmen's  tenements  appear  to  have  been  able 
to  increase  their  money  incomes  rather  more  rapidly  than 
prices  advanced,  but  in  Boston,  Philadelphia,  St.  Louis,  and  in 
smaller  towns,  their  money  incomes  appear  to  have  increased 
more  slowly  than  living  expenses.  These  conclusions  rest, 
however,  on  a  narrow  statistical  basis. 

FARM   RENTS 

The  rural  landowner  suffered  serious  injury  from  the  paper 
currency  when  he  let  his  land  for  a  money  rent.  But  renting 
farms  for  a  fixed  sum  of  money  has  always  been  less  common 
in  the  United  States  than  renting  for  a  definite  share  of  the 
products.  It  is  probable  that  at  the  time  of  the  Civil  War 
more  than  three-quarters  of  the  rented  farms  were  let  "  on 
shares."  Inasmuch  as  no  money  payments  entered  into  such 
arrangements,  the  pecuniary  relations  of  landlord  and  tenant 
were  not  directly  affected  by  the  change  in  the  monetary  stand- 
ard. Farm  owners  who  had  let  their  places  on  these  condi' 
tions  escaped  the  direct  losses  that  weighed  so  heavily  on  the 
recipients  of  money  rents.  But  even  they  did  not  avoid  all 


38  THE  GREENBACKS 

loss.  For  the  price  of  agricultural  products  for  the  greater 
part  of  the  war  period  lagged  considerably  behind  the  price  of 
other  goods.  This  difference,  of  course,  meant  loss  to  men 
whose  incomes  were  paid  in  bushels  of  grain. 

INTEREST  AND  LOAN  CAPITAL 
THE  PROBLEM  OF  LENDERS  AND  BORROWERS  OF  CAPITAL 

The  task  of  ascertaining  the  effect  of  the  greenback  issues 
upon  the  situation  of  lenders  and  borrowers  of  capital  is  in 
one  respect  more  simple  and  in  another  respect  more  complex 
than  the  task  of  dealing  with  wage-earners.  It  is  simpler  in 
that  there  are  not  different  grades  of  capital  to  be  considered 
like  the  different  grades  of  labor.  But  it  is  more  complex 
in  that  the  capitalist  must  be  considered  not  only  as  the  re- 
cipient of  a  money  income,  as  is  the  laborer,  but  also  as  the 
possessor  of  certain  property  that  may  be  affected  by  changes 
in  the  standard  money. 

The  problem  is  further  complicated  by  the  fact  that  the 
relative  importance  of  these  two  items  —  rate  of  interest  and 
value  of  principal  —  is  not  the  same  in  all  cases.  Whether  a 
lender  is  affected  more  by  the  one  item  or  the  other  depends 
upon  what  he  intends  to  do  with  his  property  at  the  expiration 
of  existing  contracts.  A  widow  left  in  1860  with  an  estate 
of  say  $10,000,  who  expected  to  keep  this  sum  constantly  at 
interest  and  to  find  new  borrowers  as  soon  as  the  old  loans 
were  paid,  could  neglect  everything  but  the  net  rate  of  interest 
received.  On  the  other  hand,  if  this  estate  had  been  left  to 
a  youth  of  twenty  who  intended  to  invest  his  property  in  some 
business  after  a  few  years,  the  rate  of  interest  would  be  of 
relatively  less  importance  to  him  than  the  purchasing  power 
of  the  principal  when  the  time  came  to  set  up  for  himself. 

Of  course,  the  same  difference  exists  in  the  case  of  different 
borrowers.  Those  borrowers  who  expected  to  renew  old  loans 
on  maturity  would  have  to  consider  little  beyond  the  interest 
demanded  by  lenders,  while  borrowers  who  expected  to  pay 
off  the  loans  out  of  the  proceeds  of  their  ventures  would  be 
interested  primarily  in  the  amount  of  goods  that  would  sell 
for  sufficient  money  to  make  up  the  principal. 


EFFECTS  UPON  INTEREST  39 

Although  these  two  classes  of  cases  are  by  no  means  inde- 
pendent of  each  other,  the  following  discussion  will  be  rendered 
clearer  by  observing  the  broad  difference  between  them.  Ac- 
cordingly, attention  will  first  be  directed  to  the  effect  of  the 
price  fluctuations  upon  the  purchasing  power  of  the  principal 
of  loans,  and  afterward  to  changes  in  the  rate  of  interest. 

PURCHASING   POWER   OF  THE   PRINCIPAL  OF  LOANS 

Most  persons  who  made  loans  in  the  earlier  part  of  the  Civil 
War  and  were  repaid  in  greenbacks  must  have  suffered  heavy 
losses  from  the  smaller  purchasing  power  of  the  principal  when 
it  was  returned  to  them.  But  while  this  general  fact  is  clear, 
it  is  difficult  to  make  a  quantitative  statement  of  the  degree  of 
the  loss  that  will  be  even  tolerably  satisfactory. 

In  the  case  of  almost  all  loans  made  before  the  middle  of 
1864  and  repaid  prior  to  1866,  the  creditor  found  that  the 
sum  returned  to  him  had  a  purchasing  power  much  less  than 
the  purchasing  power  that  had  been  transferred  to  the  borrower 
when  the  loan  was  made.  This  decline  varied  from  i  to  more 
than  50  per  cent.  On  loans  made  in  the  middle  of  1864  or 
later,  on  the  contrary,  the  creditor  gained  as  a  rule.  In  the 
case  of  loans  made  in  January,  1865,  and  repaid  six  months 
later,  the  increase  in  purchasing  power  was  over  40  per  cent. 

THE   RATE   OF   INTEREST 

In  turning  to  study  the  fortunes  of  men  who  have  no  thought 
of  employing  their  capital  for  themselves,  but  expect  to  seek 
new  borrowers  as  rapidly  as  old  loans  are  repaid,  one  finds  it 
necessary  to  distinguish  between  cases  where  loans  have  been 
made  for  short  and  for  long  terms ;  between  the  cases,  that  is, 
where  there  is  and  where  there  is  not  an  opportunity  to  make 
a  new  contract  regarding  the  rate  of  interest.  The  latter 
cases  may  be  dismissed  with  a  word.  The  capitalist  who  lent 
$10,000  for  five  years  in  April,  1862,  at  6  per  cent,  interest, 
would  be  in  relatively  the  same  position  as  the  workingman 
who  received  no  advance  in  money  wages;  while  his  money 
income  remained  the  same,  the  rise  of  prices  would  decrease 
his  real  income  in  1864. and  1865  by  about  one-half.  Of 
course,  this  loss  to  the  creditor  is  a  gain  to  the  debtor ;  for  to 


40  THE  GREENBACKS 

the  business  man  using  borrowed  capital  the  advance  of  prices 
means  that  he  can  raise  his  interest  money  by  selling  a  smaller 
proportion  of  his  output. 

More  interesting  is  the  case  of  loans  maturing  and  made 
afresh  during  the  period  under  examination.  The  important 
question  is:  How  far  did  the  lender  secure  compensation  for 
the  diminished  purchasing  power  of  the  money  in  which  he 
was  paid  by  contracting  for  a  higher  rate  of  interest? 

The  advance  in  the  rate  of  interest  was  comparatively  small 
—  much  too  small  to  compensate  for  the  increased  cost  of  liv- 
ing. While  prices  rose  approximately  85  per  cent,  and  money 
wages  somewhat  less  than  60  per  cent,  during  the  years 
1860-65,  rates  of  interest  on  call  and  time  loans  increased  less 
than  15  per  cent  during  the  same  period. 

The  conclusion  is  not  only  that  persons  who  derived  their 
income  from  capital  lent  at  interest  for  short  terms  were  in- 
jured by  the  issues  of  the  greenbacks,  but  also  that  their  in- 
juries were  more  serious  than  those  suffered  by  wage-earners. 

To  explain  this  state  of  affairs  is  not  easy.  The  first  reason 
that  suggests  itself  to  the  mind  considering  the  problem  is  that 
both  lenders  and  borrowers  failed  to  foresee  the  changes  that 
would  take  place  in  the  purchasing  power  of  money  between 
the  dates  when  loans  were  made  and  repaid.  No  doubt  there  is 
much  force  in  this  explanation.  If,  for  instance,  men  arrang- 
ing for  loans  in  April,  1862,  to  be  repaid  a  year  later,  had 
known  that  in  the  meantime  the  purchasing  power  of  money 
would  decline  30  per  cent.,  they  would  have  agreed  upon  a 
very  high  rate  of  interest.  Men  able  to  discern  the  future 
course  of  prices  would  not  have  lent  money  at  the  ordinary 
rates,  and  if  the  rates  prevailing  in  the  New  York  market 
throughout  all  1862  and  1863  were  less  than  7  per  cent.,  it 
must  have  been  because  the  extraordinary  rise  of  prices  was 
not  foreseen  by  borrowers  and  lenders. 

Nor  is  it  surprising  that  business  men  failed  to  see  what 
was  coming;  for  the  course  of  prices  depended  chiefly  upon 
the  valuation  set  upon  the  greenbacks,  and  this  valuation,  in 
turn,  depended  chiefly  upon  the  state  of  the  finances  and  the 
fortunes  of  war  —  matters  that  no  one  could  foresee  with 
certainty.  Indeed,  there  was  much  of  the  time  a  very  general 


EFFECTS  UPON  INTEREST  41 

disposition  to  take  an  imwarrantedly  optimistic  view  of  the 
military  situation  and  the  chances  of  an  early  peace.  Many 
members  of  the  business  community  seem  to  have  felt  that  the 
premium  on  gold  was  artificial  and  must  soon  drop,  that  prices 
were  inflated  and  must  collapse.  To  the  extent  that  such 
views  prevailed  borrowers  would  be  cautious  about  making 
engagements  to  repay  money  in  a  future  that  might  well  pre- 
sent a  lower  range  of  prices,  and  lenders  would  expect  a  gain 
instead  of  a  loss  from  the  changes  in  the  purchasing  power 
of  money. 

But  the  full  explanation  of  the  slight  advance  in  interest 
cannot  be  found  in  this  inability  to  foresee  the  future  —  at 
least  not  without  further  analysis  of  what  consequences  such 
inability  entailed.  Workingmen  are  commonly  credited  with 
less  foresight  than  Capitalists,  and  nevertheless  they  seem,  ac- 
cording to  the  figures,  to  have  succeeded  better  in  making  bar- 
gains with  employers  of  labour  than  did  lenders  with  employers 
of  capital.  The  explanation  of  this  less  success  seems  to  be 
found  in  the  difference  between  the  way  in  which  depreciation 
affected  what  the  capitalist  and  the  laborer  had  to  offer  in 
return  for  interest  and  wages.  There  is  no  reason  for  assum- 
ing that  an  artisan  who  changed  employers  during  the  war 
would  render  less  efficient  service  in  his  new  than  in  his  old 
position,  or  that  a  landlord  who  changed  tenants  had  less  ad- 
vantages to  put  at  the  disposal  of  the  incoming  lessee.  In 
both  these  cases  the  good  offered  to  the  active  business  man  re- 
mained substantially  the  same,  and  it  may  safely  be  assumed 
that,  other  things  being  equal,  this  business  man  could  afford 
to  give  quite  as  much  for  the  labor  and  the  land  after  as 
before  suspension.  From  the  business  man's  point  of  view, 
therefore,  there  seems  to  have  been  room  for  a  doubling  of 
money  wages  and  rent  when  the  purchasing  power  of  money 
had  fallen  one-half.  But  in  the  case  of  the  borrower  of 
capital  the  like  was  not  true.  The  thousand  dollars  which  Mr. 
A  offered  him  in  1865  was  not,  like  the  labour  of  John  Smith 
or  the  farm  of  Mr.  B,  as  efficient  for  his  purposes  as  it  would 
have  been  five  years  before.  For,  with  the  thousand  dollars 
he  could  not  purchase  anything  like  the  same  amount  of  ma- 
chinery, material,  or  labor.  And  since  the  same  nominal 


42  THE  GREENBACKS 

amount  of  capital  was  of  less  efficiency  in  the  hands  of  the 
borrower,  he  could  not  without  loss  to  himself  increase  the 
interest  which  he  paid  for  new  loans  in  proportion  to  the  de- 
cline in  the  purchasing  power  of  money,  as  he  could  increase 
the  wages  of  laborers  or  the  rent  for  land. 

It  should  also  be  pointed  out  that  on  one  important  class  of 
loans  capitalists  suffered  comparatively  little  even  during  the 
war.  Interest  on  many  forms  of  Government  bonds  was  paid 
in  gold.  Capitalists  who  invested  their  means  in  these  securi- 
ties consequently  received  an  income  of  almost  unvarying 
specie  value.  If  the  person  who  made  these  investments  were 
an  American,  he  would  be  able  to  sell  his  gold-interest  money 
at  a  high  premium,  but  he  would  also  have  to  pay  correspond- 
ingly high  prices  for  commodities,  so  that  upon  the  whole  his 
position  would  not  be  greatly  different  from  that  of  the  foreign 
investor.  That  such  opportunities  for  investment  as  these 
securities  offered  should  exist  when  men  were  most  of  the 
time  loaning  money  for  short  terms  at  7  per  cent,  or  less,  is 
perhaps  the  most  emphatic  proof  that  could  be  offered  of  the 
inability  of  the  public  to  foresee  what  the  future  had  in  store. 

PROFITS 

Laborers,  landlords,  and  lending  capitalists  are  all  alike  in 
that  the  amount  of  remuneration  received  by  them  for  the  aid 
which  they  render  to  production  is  commonly  fixed  in  advance 
by  agreement,  and  is  not  immediately  affected  by  the  profitable- 
ness or  unprofitableness  of  the  undertaking.  It  remains  to 
examine  the  economic  fortunes  of  those  men  whose  money 
incomes  are  made  up  by  the  sums  left  over  in  any  business 
after  all  the  stipulated  expenses  have  been  met. 

A  very  important  part  of  the  solution  of  the  problem  of 
profits  has  already  been  contributed  by  the  preceding  studies 
of  wages,  rent,  and  interest.  The  evidence  has  been  found  to 
support  the  conclusion  that  in  almost  all  cases  the  sums  of 
money  wages,  rent,  and  interest  received  by  laborers,  land- 
lords, and  capitalists  increased  much  less  rapidly  than  did  the 
general  price  level.  If  the  wording  of  this  conclusion  be  re- 
versed—  the  prices  of  products  rose  more  rapidly  than  wages, 
rent,  or  interest  —  we  come  at  once  to  the  proposition  that  as  a 


EFFECTS  UPON  PROFITS  43 

rule  profits  must  have  increased  more  rapidly  than  prices.  For, 
if  the  sums  paid  to  all  the  other  co-operating  parties  were  in- 
creased in  just  the  same  ratio  as  the  prices  of  the  articles  sold, 
it  would  follow  that,  other  things  remaining  the  same,  money 
profits  also  would  increase  in  the  same  ratio.  But  if,  while 
prices  doubled,  the  payments  to  labourers,  landlords,  and  capi- 
talists increased  in  any  ratio  less  than  100  per  cent.,  the  sums 
of  money  left  for  the  residual  claimants  must  have  more 
than  doubled.  In  other  words,  the  effect  of  the  depreciation 
of  the  paper  currency  upon  the  distribution  of  wealth  may  be 
summed  up  in  the  proposition:  The  shares  of  wage-earners, 
landowners,  and  lenders  in  the  national  dividend  were  dimin- 
ished and  the  share  of  residual  claimants  was  increased. 

Two  other  general  propositions  respecting  profits  are  sug- 
gested. First,  other  things  being  equal,  profits  varied  in- 
versely as  the  average  wage  per  day  paid  to  employees.  This 
conclusion  follows  directly  from  the  fact  that  the  money  wages 
of  men  earning  $i— $1.49  per  day  before  the  perturbation  of 
prices  increased  in  higher  ratio  than  those  of  men  earning 
$1.50-^1.99;  that  the  wages  of  the  latter  class  increased  more 
than  the  wages  of  men  in  the  next  higher  wage  class,  etc. 
Second,  other  things  being  equal,  profits  varied  directly  as  the 
complexity  of  the  business  organization.  By  this  proposition 
is  meant,  for  example,  that  a  farmer  who  paid  money  rent, 
used  borrowed  capital,  and  employed  hired  labourers,  made  a 
higher  percentage  of  profits  than  a  farmer  of  whom  any  one 
of  these  suppositions  did  not  hold  true.  If,  as  has  been 
argued,  the  increase  of  profits  was  made  at  the  expense  of 
laborers,  landlords,  and  capitalists,  it  follows  that  that 
entrepreneur  fared  best  whose  contracts  enabled  him  to  ex- 
ploit the  largest  number  of  these  other  persons. 

PROFITS   IN   AGRICULTURE 

The  farmers  of  the  loyal  states  were  among  the  unfortunate 
producers  whose  products  rose  in  price  less  than  the  majority 
of  other  articles,  and  from  this  standpoint  they  were  losers 
rather  than  gainers  by  the  paper  currency.  Of  course,  it  is 
possible  that  the  farmer's  loss  from  this  inequality  of  price 
fluctuations  might  be  more  than  offset  by  his  gains  at  the 


44  THE  GREENBACKS 

expense  of  labourers,  landlord,  and.  lending  capitalist.  But 
there  is  good  reason  for  believing  that  the  increase  of  the  entre- 
preneur's profits  in  the  latter  fashion  was  less  in  farming  than 
in  any  other  important  industry.  This  conclusion  seems  to 
follow  from  the  proposition  that,  other  tilings  being  equal, 
profits  varied  directly  as  the  complexity  of  business  organiza- 
tion. The  American  farmers  of  the  Civil  War  were  in  a  large 
proportion  of  cases  their  own  landlords,  capitalists,  and  labor- 
ers. So  far  as  this  was  true,  they  had  few  important  pecuniary 
contracts  with  other  persons  of  which  they  could  take  ad- 
vantage by  paying  in  depreciated  dollars.  Of  those  farmers 
who  hired  labor  very  many  paid  wages  partly  in  board  and 
lodging  —  an  arrangement  which  threw  a  considerable  part  of 
the  increased  cost  of  living  upon  them  instead  of  upon  their 
employees.  Finally,  the  renting  farmer  probably  gained  less 
on  the  average  from  the  contract  with  his  landlord  than  tenants 
of  any  other  class,  because  in  a  majority  of  cases  the  rent  was 
not  a  sum  of  money,  but  a  share  of  the  produce.  While,  then, 
the  general  effect  of  the  paper  standard  was  in  the  direction 
of  increasing  profits,  it-  seems  very  doubtful  whether  farmers 
as  a  whole  did  not  lose  more  than  they  gained  because  of  the 
price  disturbances. 

STATISTICAL   EVIDENCE   REGARDING   PROFITS 

It  would  be  highly  desirable  to  test  our  general  conclusions 
by  means  of  direct  information  regarding  profits  made  in 
various  branches  of  trade,  but  the  data  available  for  such  a 
purpose  are  very  meager.  WThat  scraps  of  information  are 
available,  however,  support  the  view  that  profits  were  uncom- 
monly large.  Mr.  David  A.  Wells,  for  example,  in  his  re- 
ports as  special  commissioner  of  the  revenue,  has  stories  of 
"  most  anomalous  and  extraordinary "  profits  that  were 
realized  in  the  paper,  woolen,  pig-iron,  and  salt  industries.  A 
more  general  indication  of  the  profitableness  of  business  is 
afforded  by  the  remark  in  the  annual  circular  of  Dun's  Mer- 
cantile Agency  for  1864,  that  "it  is  generally  conceded  that 
the  average  profits  on  trade  range  from  12  to  15  per  cent." 

But  the  most  important  piece  of  evidence  is  found  in  the 
statistics  of  failures  compiled  by  the  same  agency.  The  fol- 


EFFECTS  UPON  PROFITS  45 

lowing  table  shows  Dun's  report  of  the  number  of  bankrupt- 
cies and  the  amount  of  liabilities  in  the  loyal  States  from  the 
panic  year  1857  to  the  end  of  the  war : 

Year                  Number  Liabilities  Year                  Number  Liabilities 

1857  4,257  $265,500,000  1861  5,935  $178,600,000 

1858  3,1 13  73,600,000  1862  1,652  23,000,000 

1859  2,959  51,300,000  1863  495  7,900,000 

1860  2,733  61,700,000  1864  510  8,600,000 

1865     500        17,600,000 

The  very  great  decrease  both  in  the  number  and  the  liabilities 
of  firms  that  failed  is  the  best  proof  that  almost  all  business 
enterprises  were  "  making  money." 

From  one  point  of  view  the  small  number  of  failures  is 
surprising.  An  unstable  currency  is  generally  held  to  make 
business  unsafe,  and  seldom  has  the  standard  money  of  a  mer- 
cantile community  proven  so  unstable,  undergone  such  violent 
fluctuations  in  so  short  a  time,  as  in  the  United  States  during 
the  Civil  War.  Yet,  instead  of  being  extremely  hazardous, 
business  seems  from  the  statistics  of  failures  to  have  been 
more  than  usually  safe. 

The  explanation  of  the  anomaly  seems  to  be  that  the  very 
extremity  of  the  danger  proved  a  safeguard.  Business  men 
realized  that  the  inflation  of  prices  was  due  to  the  depreciation 
of  the  currency,  and  that  when  the  war  was  over  gold  would 
fall  and  prices  follow.  They  realized  very  clearly  the  neces- 
sity of  taking  precautions  against  being  caught  in  a  position 
where  a  sudden  decline  of  prices  would  ruin  them.  They  did 
this  by  curtailing  credits.  So  long  as  prices  continued  to  rise 
such  precautions  were  really  not  needed  by  the  man  in  active 
business  except,  in  so  far  as  he  was  a  creditor  of  other  men; 
but  when  prices  commenced  to  fall  prudence  had  its  reward. 
Such  a  sudden  and  violent  drop  of  prices  as  occurred  between 
January  and  July,  1865,  would  have  brought  a  financial  re- 
vulsion of  a  most  serious  character  upon  a  business  community 
under  ordinary  circumstances.  But  so  well  had  the  change 
been  prepared  for,  that  the  number  of  failures  was  actually 
less  than.it  had  been  in  the  preceding  year  of  rapidly  rising 
prices. 

The  whole  situation  can  hardly  be  explained  better  than  it 
was  by  a  New  York  business  man  writing  in  Harper's  Monthly 


46  THE  GREENBACKS 

Magazine:  "  When  the  war  ended,"  he  said,  "  we  all  knew  we 
should  have  a  panic.  Some  of  us,  like  Mr.  Hoar,  expected  that 
greenbacks  and  volunteers  would  be  disbanded  together. 
Others  expected  gold  to  fall  to  101  or  102  in  a  few  days. 
Others  saw  a  collapse  of  manufacturing  industry,  owing  to 
the  cessation  of  Government  purchases.  But  we  all  knew  a 
'  crisis  '  was  coming,  and  having  set  our  houses  in  order  accord- 
ingly, the  '  crisis  '  of  course  never  came." 

THE  PRODUCTION  AND  CONSUMPTION  OF  WEALTH 
PRODUCTION 

What  influence  did  the  greenback  currency  have  as  one  of 
the  many  factors  that  affected  the  production  of  wealth?  In 
the  first  place,  the  paper  standard  was  responsible  in  large 
measure  for  the  feeling  of  "  prosperity  "  that  seems  from  all 
the  evidence  to  have  characterized  the  public's  frame  of  mind. 
Almost  every  owner  of  property  found  that  the  price  of  his 
possessions  had  increased,  and  almost  every  wage-earner 
found  that  his  pay  was  advanced.  Strive  as  people  may  to 
emancipate  themselves  from  the  feeling  that  a  dollar  represents 
a  fixed  quantity  of  desirable  things,  it  is  very  difficult  for  them 
to  resist  a  pleasurable  sensation  when  the  money  value  of  their 
property  rises  or  their  incomes  increase.  They  are  almost 
certain  to  feel  cheerful  over  the  larger  sums  that  they  can 
spend,  even  though  the  amount  of  commodities  the  larger 
sums  will  buy  is  decreased.  Habit  is  too  strong  for  arith- 
metic. 

But,  more  than  this,  "  business  "  in  the  common  meaning 
of  the  word  was  unusually  profitable  during  the  war.  The 
"  residual  claimant "  is  in  most  enterprises  the  active  business 
man,  and,  as  has  been  shown,  his  money  income  did  as  a  rule 
rise  more  rapidly  than  the  cost  of  living.  In  other  words, 
"  business  "  was,  in  reality  as  well  as  in  appearance,  rendered 
more  profitable  by  the  greenbacks.  There  is  therefore  no  error 
in  saying  that  the  business  of  the  country  enjoyed  unwonted 
prosperity  during  the  war.  And  it  may  be  added  that  the 
active  business  man  is  probably  a  more  potent  factor  in  de- 
termining the  community's  feeling  about  "  good  times  "  and 


EFFECTS  UPON  PRODUCTION  47 

"  bad  times  "  than  is  the  workingman,  the  landlord,  or  the 
lending  capitalist. 

The  effect  of  high  profits,  however,  is  not  limited  to  produc- 
ing a  cheerful  frame  of  mind  among  business  men.  Under 
ordinary  circumstances  one  would  say  that  when  the  great 
majority  of  men  already  in  business  are  "  making  money  " 
with  more  than  usual  rapidity  they  will  be  inclined  to  enlarge 
their  operations,  that  others  will  be  inclined  to  enter  the  field, 
and  that  thus  the  production  of  wealth  will  be  stimulated.  But 
the  circumstances  of  the  war  period  were  not  ordinary  and 
this  conclusion  cannot  be  accepted  without  serious  modifica- 
tions. 

1.  It  has  been  shown  that  business  men  realised  the  pre- 
cariousness  of  all  operations  that  depended  for  their  success 
upon  the  future  course  of  prices  —  and  nearly  all  operations 
that  involved  any  considerable  time  for  their  consummation 
were  thus  dependent.     So  far  did  this  disposition  prevail  that 
it  produced  a  marked  curtailment  in  the  use  of  credit.     The 
prudent  man  might  be  willing  to  push  his  business  as  far  as 
possible  with  the  means  at  his  own  disposal,  but  he  showed  a 
disinclination  to  borrow  for  the  purpose.     Thus  the  uncer- 
tainty which  all  men  felt  about  the  future  in  a  large  measure 
counteracted  the  influence  of  high  profits  in  increasing  pro- 
duction. 

2.  The   foregoing  consideration  of  course  weighed  most 
heavily  in  the  minds  of  cautious  men.     But  not  all  business 
men  are  cautious.     Among  many  the  chance  of  winning  large 
profits  in  case  of  success  is  sufficient  to  induce  them  to  under- 
take heavy  risks  of  loss.     On  the  whole,  Americans  seem  to 
display  a  decided  propensity  toward  speculative  ventures  and 
are  not  easily  deterred  by  having  to  take  chances.     To  men 
of  this  type  it  seems  that  the  business  opportunities  offered 
by  the  fluctuating  currency  would  make  a  strong  appeal.     But, 
while  the  force  of  this  observation  may  be  admitted,  it  does  not 
necessitate  a  reconsideration  of  the  conclusion  that  the  in- 
stability of  prices  tended  to  diminish  the  production  of  wealth. 
For  in  a  time  of  great  price  fluctuations  the  possibilities  of 
making  fortunes  rapidly  are  much  greater  in  trade  than  in 
agriculture,  mining,  or  manufactures.     Every  rise  and  fall  in 


48  THE  GREENBACKS 

quotations  holds  out  an  alluring  promise  of  quick  gain  to  the 
man  who  believes  in  his  shrewdness  and  good  fortune,  and 
who  does  not  hesitate  to  take  chances.  The  probable  profits 
of  productive  industry  in  the  narrower  sense  might  be  larger 
than  common,  but  this  would  not  attract  investors  in  large 
numbers  if  the  probable  profits  of  trading  were  larger  yet; 
and  such  seems  clearly  to  have  been  the  case  during  the  war 
when  the  paper  currency  offered  such  brilliant  possibilities  to 
fortunate  speculators  in  gold,  in  stocks,  or  in  commodities. 
Instead,  then,  of  the  greenbacks  being  credited  with  stimulat- 
ing the  production  of  wealth,  they  must  be  charged  with  offer- 
ing inducements  to  abandon  agriculture  and  manufactures  for 
the  more  speculative  forms  of  trade. 

This  tendency  of  the  times  did  not  escape  observation.  On 
the  contrary,  it  was  often  remarked  and  lamented  in  terms  that 
seem  exaggerated.  Hugh  McCulloch,  for  instance,  in  his  re- 
port as  Secretary  of  the  Treasury  for  1865,  said: 

There  are  no  indications  of  real  and  permanent  prosperity  .  .  . 
in  the  splendid  fortunes  reported  to  be  made  by  skilful  manipulations 
at  the  gold  room  or  the  stock  board ;  no  evidences  of  increasing  wealth 
in  the  facts  that  railroads  and  steamboats  are  crowded  with  passen- 
gers, and  hotels  with  guests;  that  cities  are  full  to  overflowing, 
and  rents  and  the  necessities  of  life,  as  well  as  luxuries,  are  daily 
advancing.  All  these  things  prove  rather  .  .  .  that  the  number  of 
non-producers  is  increasing,  and  that  productive  industry  is  being 
diminished. 

In  one  of  his  reports  as  special  commissioner  of  the  revenue, 
Mr.  Wells  said :  « 

During  the  last  few  years  large  numbers  of  our  population,  un- 
der the  influence  and  example  of  high  profits  realized  in  trading 
during  the  period  of  monetary  expansion,  have  abandoned  employ- 
ments directly  productive  of  national  wealth,  and  sought  employments 
connected  with  commerce,  trading,  or  speculation.  As  a  consequence 
we  everywhere  find  large  additions  to  the  population  of  our  com- 
mercial cities,  an  increase  in  the  number  and  cost  of  the  buildings 
devoted  to  banking,  brokerage,  insurance,  commission  business,  and 
agencies  of  all  kinds,  the  spirit  of  trading  and  speculating  pervad- 
ing the  whole  community,  as  distinguished  from  the  spirit  of  pro- 
duction. 

Within  the  period  under  review,  then,  it  seems  very  doubtful 
whether  the  high  profits  had  their  usual  effect  of  leading  to  a 


EFFECTS  UPON  CONSUMPTION  49 

larger  production  of  raw  materials  or  to  an  increase  in  manu- 
factures. The  prudent  man  hesitated  to  expand  his  under- 
takings because  of  the  instability  of  the  inflated  level  of  prices ; 
the  man  with  a  turn  for  speculative  ventures  found  more  allur- 
ing opportunities  in  trade. 

CONSUMPTION 

No  one  can  read  contemporary  comments  on  American 
social  life  of  the  later  years  of  the  war  without  being  im- 
pressed by  the  charges  of  extravagance  made  against  the  people 
of  the  North.  Newspapers  and  pulpits  were  at  one  in  de- 
nouncing the  sinful  waste  that,  they  declared,  was  increasing 
at  a  most  alarming  rate.  The  "  shoddy  aristocracy  "  with  its 
ostentatious  display  of  wealth  became  a  stock  subject  for  car- 
toonists at  home,  and  earned  a  well-merited  reputation  for 
vulgarity  abroad. 

In  trying  to  account  for  this  unpleasant  phase  of  social 
development,  men  usually  laid  the  blame  upon  the  paper 
standard.  High  prices  were  said  to  make  every  one  feel  sud- 
denly richer  and  so  to  tempt  every  one  to  adopt  a  more  lavish 
style  of  living  than  his  former  wont.  Thus  the  view  gained 
general  credence  that  the  greenbacks  were  ultimately  re- 
sponsible for  a  great  increase  in  the  consumption  of  wealth. 

However,  such  a  view  regarding  the  consumption  of  wealth 
can  be  but  partially  true.  The  enormous  profits  of  entre- 
preneurs made  possible  the  rapid  accumulation  of  an  unusual 
number  of  fortunes,  and  the  families  thus  lifted  into  sudden 
affluence  enjoyed  spending  their  money  in  the  ostentatious 
fashion  characteristic  of  the  newly  rich.  It  is  therefore  true 
that  the  monetary  situation  was  largely  responsible  for  the 
appearance  of  a  considerable  class  of  persons  —  of  whom  the 
fortunate  speculator  and  the  army  contractor  are  typical  — 
who  plunged  into  the  recklessly  extravagant  habits  that 
called  down  upon  their  heads  the  condemnation  of  the  popular 
moralist. 

But  if  the  greenbacks  were  in  the  last  resort  a  chief  cause 
of  the  increased  consumption  of  articles  of  luxury  by  families 
whom  they  had  aided  in  enriching,  they  were  not  less  truly  a 
cause  of  restricted  consumption  by  a  much  larger  class  of 


50  THE  GREENBACKS 

humbler  folk.  The  laboring  man  whose  money  wages  in- 
creased but  one-half,  while  the  cost  of  living  doubled,  could 
not  continue  to  provide  for  his  family's  wants  so  fully  as 
before.  He  was  forced  to  practise  economies  —  to  wear  his 
old  clothing  longer,  to  use  less  coffee  and  less  sugar,  to  substi- 
tute cheaper  for  better  qualities  in  every  line  of  expenditure 
where  possible.  Similar  retrenchment  of  living  expenses  must 
have  been  practised  by  the  families  of  many  owners  of  land  and 
lenders  of  capital.  In  other  words,  the  war  time  fortunes 
resulted  in  a  very  large  measure  from  the  mere  transfer  of 
wealth  from  a  wide  circle  of  persons  to  the  relatively  small 
number  of  residual  claimants  to  the  proceeds  of  business  en- 
terprises. The  enlarged  consumption  of  wealth  which  the 
paper  currency  made  possible  for  the  fortunate  few  was  there- 
fore contrasted  with  a  diminished  consumption  on  the  part 
of  the  unfortunate  many  on  whose  slender  means  the  green- 
backs levied  contributions  for  the  benefit  of  their  employers. 

That  the  diminished  consumption  of  wealth  by  large  num- 
bers of  poor  people  escaped  general  notice,  while  the  ex- 
travagance of  the  newly  rich  attracted  so  much  attention,  need 
not  shake  one's  confidence  in  the  validity  of  these  conclusions. 
The  purchase  of  a  fast  trotting-horse  by  a  Government  con- 
tractor, and  the  elaborateness  of  his  wife's  gowns  and 
jewelry,  are  much  more  conspicuous  facts  than  the  petty 
economies  practised  by  his  employees.  The  same  trait  that 
leads  fortunate  people  to  flaunt  their  material  prosperity  in  the 
eyes  of  the  world  leads  the  unfortunate  to  conceal  their  small 
privations.  Even  an  attentive  observer  may  fail  to  notice  that 
the  wives  of  workingmen  are  still  wearing  their  last  year's 
dresses  and  that  the  children  are  running  barefoot  longer  than 
usual. 

But  though  the  newspapers  were  not  full  of  comments  on 
the  enforced  economies  of  the  mass  of  the  population,  whole- 
sale dealers  in  staple  articles  of  food  and  clothing  noticed  a 
decrease  in  sales.  In  reviewing  the  trade  situation  in  Sep- 
tember, 1864,  when  real  wages  were  near  their  lowest  ebb, 
Hunt's  Merchants'  Magazine  remarked  that  "  the  rise  in  the 
prices  of  commodities  has  .  .  .  outrun  the  power  of  consump- 
tion and  the  fall  trade  has  been  almost  at  a  stand.  Those 


EFFECTS  UPON  COST  OF  WAR  51 

articles  such  as  coffee,  sugar,  low  grade  goods,  which  form  the 
staple  products  of  the  great  mass  of  the  people  in  moderate 
circumstances,  have  reached  such  high  rates  that  the  decline 
in  consumption  is  very  marked,  amounting  almost  to  a  stagna- 
tion of  the  fall  trade."  The  consumption  of  many  articles 
of  luxury  increased  very  greatly,  while  the  consumption  of 
many  staple  articles  declined. 


The  reader  who  goes  back  to  the  debates  upon  the  legal- 
tender  bills  will  find  that  most  of  the  unfortunate  consequences 
that  followed  their  enactment  were  foretold  in  Congress  — 
the  decline  of  real  wages,  the  injury  done  creditors,  the  uncer- 
tainty of  prices  that  hampered  legitimate  business  and  fostered 
speculation.  But  a  majority  of  this  Congress  were  ready  to 
subject  the  community  to  such  ills  because  they  believed  that 
the  relief  of  the  treasury  from  its  embarrassments  was  of  more 
importance  than  the  maintenance  of  a  relatively  stable  mon- 
etary standard. 

GREENBACKS   AND   EXPENDITURES 

What  effect  had  the  greenbacks  upon  the  amount  of  ex- 
penditures incurred  ?  Few  questions  raised  by  the  legal-tender 
acts  have  attracted  more  attention  than  this.  Even  while  the 
first  legal-tender  bill  was  being  considered  its  critics  declared 
that  if  made  a  law  it  would  increase  the  cost  of  waging  the 
war  by  causing  an  advance  in  the  prices  of  articles  that  the 
Government  had  to  buy.  As  the  war  went  on  the  soundness 
of  this  view  became  apparent. 

When  the  war  was  over  and  the  divers  reasons  that  had 
deterred  many  men  from  criticizing  the  financial  policy  of  the 
government  were  removed,  competent  writers  began  to  express 
similar  views  with  freedom.  For  example,  Mr.  C.  P.  Wil- 
liams put  the  increase  of  debt  at  one-third  to  two-fifths ;  S.  T. 
Spear,  at  a  billion  dollars;  L.  H.  Courtney,  an  English  critic, 
at  nearly  $900,000,000.  Of  later  discussions  that  of  H.  C. 
Adams  has  attracted  the  most  attention.  He  estimated  that 
of  the  gross  receipts  from  debts  created  between  January  I, 


52  THE  GREENBACKS 

1862,  and  September  30,  1865,  amounting  to  $2,565,000,000 
the  gold  value  was  but  $1,695,000,000  —  a  difference  of 
$870,000,000  between  value  received  and  obligations  incurred. 
A  detailed  consideration  of  the  elements  that  enter  the 
problem  would  seem  to  warrant  a  reduction  of  the  estimates 
given  to  $791,000,000.  It  is  hardly  necessary  to  insist  stren- 
uously that  this  is  but  a  very  rough  estimate. 

THE   GREENBACKS   AND   RECEIPTS 

The  total  increase  of  receipts  was  approximately  $174,- 
000,000,  as  shown  in  the  following  table : 

(In  millions  of  dollars) 

1862  1866 

(Six  Fiscal  Year  (Two 

Months)  1863  1864  1865  Months) 
Current  receipts : 

From   customs    33-5  69-1  102.3  84.9        31.3 

From  sales  of  public  lands i  .2  .6  i.o           .1 

From   direct  tax    1.8  1.5  .5  1.2            .o 

From  miscellaneous  sources 5  3.0  47.5  33.0        12.3 

From  internal   revenue    37.6  109.7  2°9-S        64.4 


35.9      111.4      260.6      329.6      108.1 
Estimated  actual  increase   o  10          39         106  19 

The  caution  is  hardly  necessary  that  the  above  results  are 
to  be  accepted  subject  also  to  a  wide  margin  of  error. 

There  were  other  financial  consequences  of  the  shift  from 
the  specie  to  the  paper  standard,  however,  that  were  not  unim- 
portant, though  they  were  indirect  and  difficult  to  gauge.  Two 
of  the  most  prominent  must  be  indicated. 

1.  It  is  probable  that  not  a  little  of  the  lavishness  with  which 
public  funds  were  appropriated  by  Congress  during  the  war 
can  be  traced  to  the  paper-money  policy. 

2.  If  the  paper  currency  tempted  the  Government  to  reckless 
expenditures,  it  also  predisposed  the  people  to  submit  more 
willingly  to  heavy  taxation.     It  has  been  remarked  several 
times  that  the  advance  of  money  wages  and  of  money  prices 
made  most  people  feel  wealthier,  and,  feeling  wealthier,  they 
were  less  inclined  to  grumble  over  the  taxes. 

While  these  indirect  effects  of  the  paper  currency  on  ex- 
penditures and  receipte  could  not  by  any  system  of  bookkeep- 


CONTRACTION  AND  INFLATION  '53 

ing  be  brought  to  definite  quantitative  statement,  it  is  probable 
that  their  net  result  was  unfavorable  to  the  treasury. 

CONTRACTION  AND  INFLATION  OF  THE  LEGAL  TENDERS  * 

The  policy  of  a  permanent  currency  of  government  legal- 
tender  paper  at  the  close  of  the  Civil  War  was  unknown.  Up- 
wards of  four  hundred  million  notes  of  the  United  States  were, 
it  is  true,  in  circulation  at  the  return  of  peace.  There  were 
doubtless  many  individuals  who  approved  the  continuance  of 
exactly  this  form  of  currency.  But  no  such  proposition  had 
been  advanced  by  any  public  man  of  influence  or  by  any  politi- 
cal organization.  That  the  resort  to  legal-tender  powers  was 
an  evil  justified  only  by  extreme  emergency,  and  that  the  cir- 
culation of  government  notes  in  any  form  was  a  purely  tem- 
porary measure,  were  the  unanimous  convictions  of  the  states- 
men who  contrived  the  system.  The  logical  inference  that 
these  Government  notes  would  be  paid  off  and  cancelled,  as 
soon  as  the  war  deficiency  had  ended,  was  publicly  accepted. 

Such  was  the  theory  and  purpose  of  the  public  men  through 
whom  the  Legal-Tender  Act  was  constructed  and  applied. 
Nor  is  the  general  position  of  our  statesmen,  at  the  close  of 
the  Civil  War,  any  more  obscure  than  their  original  position. 
The  first  financial  resolution  adopted  by  Congress,  in  Decem- 
ber, 1865,  was  an  explicit  promise  to  retire  the  legal  tenders. 
The  first  legislation  of  that  Congress  gave  discretionary  powers 
to  the  Secretary  of  the  Treasury  for  continuous  contraction. 
Very  few  legislative  victories  are  won  without  at  least  a  tem- 
porary popular  endorsement,  and  the  votes  of  December,  1865, 
and  of  March,  1866,  were  no  exceptions.  But  the  popular 
approval  of  contraction  in  that  year,  exception  as  it  was  to  all 
our  subsequent  legislation,  is  readily  enough  explained.  Pub- 
lic opinion,  when  the  war  ended,  was  governed  by  impatience 
with  inflated  prices;  inflation  far  beyond  the  European  level, 
and  properly  ascribed  to  the  condition  of  the  currency.  The 
cost  of  living  reached  during  1865  the  highest  point  recorded 
in  this  country's  history.  From  1860  to  1865,  inclusive,  the 
average  of  European  prices  rose  only  4  to  6  per  cent. ;  average 

1  Adapted  from  A.  D.  Noyes,  Forty  Years  of  American  Finance,  pp. 
7-20.  G.  P.  Putnam's  Sons,  New  York  and  London,  1909, 


54  THE  GREENBACKS 

prices  in  the  United  States  advanced,  in  the  same  period,  no 
less  than  116  per  cent.  With  flour  at  $16  a  barrel,  butter  at 

55  cents  a  pound,  coal  at  $10  a  ton,  and  wages  and  salaries 
advanced  since  1860  hardly  one-third  as  far  as  prices,  the 
demand    for   currency    reform    obtained    ready    endorsement 
from  the  people. 

This  popular  sentiment  was  further  strengthened  by  the  Ad- 
ministration's attitude  at  the  opening  of  Lincoln's  second  term. 
Mr.  McCulloch's  first  official  Treasury  report,  dated  Decem- 
ber 4,  1865,  took  positive  ground  for  the  reduction  of  the 
legal-tender  debt.  He  asked  authority  to  issue  bonds  in  his 
discretion,  at  6  per  cent,  or  less,  "  for  the  purpose  of  retiring 
not  only  the  compound  interest  notes,  but  the  United  States 
notes." 

Two  weeks  after  the  publication  of  this  report,  on  December 
1 8,  1865,  the  House  of  Representatives  resolved,  by  a  vote  of 
144  to  6, 

that  this  house  cordially  concurs  in  the  view  of  the  Secretary  of 
the  Treasury  in  relation  to  the  necessity  of  a  contraction  of  the 
currency,  with  a  view  to  as  early  a  resumption  of  specie  payments 
as  the  business  interests  of  this  country  will  permit;  and  we  hereby 
pledge  co-operative  action  to  this  end  as  speedily  as  practicable. 

This  resolution  of  1865,  however,  marked  the  climax  of  the 
movement.  Never  thereafter  did  the  policy  of  retiring  the 
legal-tender  notes  even  approach  success.  The  truth  is,  that 
the  inflated  prices  had  begun  already,  during  the  three  months 
after  the  resolution  of  December,  to  recede.  This  was  inevi- 
table, from  the  very  nature  of  the  previous  expansion;  and 
it  was  a  welcome  movement  to  consumers.  But  it  necessarily 
caused  some  derangement  in  the  plans  of  trade,  and  politicians 
began  to  ask,  when  they  had  to  face  the  fulfilment  of  their 
pledge  through  a  formal  act  of  Congress,  how  the  contraction 
policy  would  be  greeted  by  producers.  The  bill,  as  originally 
introduced,  granted  full  powers  to  the  Secretary  of  the  Treas- 
ury to  issue  new  bonds  for  the  retirement  both  of  interest- 
bearing  and  of  non-interest-bearing  debt.  In  the  spring  of 
1866  this  measure  was  defeated  in  the  House  of  Representa- 
tives by  a  vote  of  70  to  64.  Reconsidered  and  amended  so  as 
to  restrict  contraction  of  the  legal  tenders  to  $10,000,000  in 


CONTRACTION  AND  INFLATION  55 

the  first  six  months  and  to  $4,000,000  per  month  thereafter, 
the  compromise  measure  did  indeed  pass  the  House  by  83  to 
53,  and  the  Senate  by  32  to  7.  But  a  victory  thus  won  was 
ominous.  Mr.  McCulloch  himself  declared  the  amended  act 
to  be  awkward  and  ineffective.  Still  more  significant  was  the 
character  of  opposition  developed  in  the  course  of  the  debate. 
It  had  a  dozen  varying  grounds  of  argument,  most  of  them 
pretty  certain  to  appeal  to  popular  prejudice  later  on.  Some 
Congressmen  objected  to  the  discretionary  powers  as  revolu- 
tionary, and,  while  conceding  Mr.  McCulloch's  ability  and  con- 
servatism, pointed  out  that  a  very  different  Treasury  Secretary 
might  succeed  him.  Others  pronounced  the  notion  of  imme- 
diate resumption  of  specie  payments  to  be  "  Utopian  in  the 
extreme."  Much  was  heard  of  the  comfortable  theory  that 
if  Congress  would  "  allow  things  to  go  on  without  active  inter- 
ference," the  "  natural  development  of  events  "  would  auto- 
matically bring  about  resumption.  More  than  one  legislator 
could  not  understand,  "  when  we  have  $450,000,000  [debt] 
bearing  no  interest,  and  which  need  bear  no  interest,  why  it 
is  to  be  taken  up  and  put  into  bonds."  The  excellence  of  a 
circulating  medium  "  that  rests  on  the  property  of  the  whole 
country,  and  has  for  its  security  the  faith  and  patriotism  of 
the  greatest  and  freest  country  on  the  face  of  the  globe," 
played  its  usual  part  in  the  discussion;  so  did  the  argument 
that  "  the  amount  of  legal  tenders  now  outstanding  is  not  too 
much  for  the  present  condition  of  the  country."  In  short,  all 
the  arguments  which  have  been  made  familiar  by  the  twenty 
subsequent  years  of  controversy,  cut  a  figure  in  this  opening 
discussion. 

As  a  matter  of  fact,  even  the  restricted  powers  of  note  re- 
tirement granted  under  the  law  of  March,  1866,  were  revoked 
within  two  years.  Little  or  no  progress  had  meantime  been 
made  towards  resumption  of  specie  payments.  The  Secretary 
himself  had  officially  pointed  out  that  two  commercial  in- 
fluences must  be  removed  before  resumption  would  be  possible ; 
the  excessively  high  prices  in  the  United  States  and  the  heavy 
balance  of  foreign  trade  against  us.  But  prices  continued 
above  the  European  level,  and,  as  a  consequence,  export  of 
merchandise  was  checked  and  imports  greatly  stimulated.  The 


56  THE  GREENBACKS 

entire  gold  product  of  each  year  in  the  United  States  was  sent 
abroad. 

Contraction  of  the  inflated  currency,  even  if  pursued  under 
the  limitations  of  the  Act  of  1866,  would  in  time  have  brought 
about  conditions  under  which  resumption  might  have  been 
planned.  But  events  outside  of  the  United  States  now  moved 
in  such  a  way  as  to  turn  the  entire  financial  community  against 
the  Secretary's  policy.  Hardly  two  months  after  the  vote  of 
March  came  a  wholly  unexpected  crisis  in  the  foreign  money 
markets.  The  London  collapse,  precipitated  by  the  Overend- 
Gurney  failure  of  May,  1866,  was  in  some  respects  as  com- 
plete as  any  in  the  history  of  England.  It  affected  every  na- 
tion with  which  Great  Britain  had  commercial  dealings;  not 
least  of  all  the  United  States,  of  whose  securities  it  was  esti- 
mated that  European  investors  even  then  held  $600,000,000. 
During  three  months  the  Bank  of  England  kept  its  minimum 
discount  rate  at  the  panic  figure  of  10  per  cent. ;  the  con- 
sequent sudden  recall  of  foreign  capital  put  a  heavy  strain  on 
the  American  markets. 

With  the  familiar  disposition  of  the  trade  community  to 
lay  the  blame  for  disordered  markets  on  some  move  of  public 
policy,  the  Treasury's  operations  to  reduce  outstanding  notes 
were  made  the  scapegoat.  Politicians  with  an  eye  to  popular- 
ity were  quick  to  catch  this  drift  of  public  sentiment.  Some 
of  them  honestly  believed  that  McCulloch's  action  in  the  cur- 
rency was  the  cause  of  the  trade  distress;  others,  better  in- 
formed but  equally  politic,  avoided  personal  declaration  of 
opinion,  but  characteristically  announced  that  whether  the 
theory  was  correct  or  not,  the  public  believed  it,  and  that  in 
deference  to  the  public,  currency  contraction  ought  to  cease. 
The  usual  result  ensued.  Under  the  previous  question,  and 
without  debate,  a  measure  revoking  absolutely  the  Secretary's 
power  of  contraction  passed  the  House  of  Representatives  in 
December,  1867,  by  a  vote  of  127  to  32.  In  the  Senate  there 
was  an  able  show  of  opposition,  but  it  was  plainly  put  on  the 
defensive,  and  on  January  22,  1868,  the  resolution  passed  both 
chambers  in  its  original  and  final  shape. 

This  was  the  end  of  the  McCulloch  plan.  It  was  the  end 
of  all  serious  debate  upon  resumption,  for  at  least  six  years. 


CONTRACTION  AND  INFLATION  '57 

It  was  also,  and  very  logically,  the  beginning  of  the  fiat-money 
party.  The  Republicans  were  forced  into  open  defence  of 
sound  financial  principles  by  the  very  recklessness  of  their 
opponents.  Helped  by  the  great  personal  prestige  of  its  candi- 
date, General  Grant,  the  Republican  party  won  a  sweeping 
victory.  President  Johnson,  who  was  then  at  open  odds  with 
his  party,  had  produced  in  his  Annual  Message  of  December 
7,  1868,  the  extraordinary  suggestion  that  "  the  6  per  cent, 
interest  now  paid  by  the  Government  "  on  its  debt  "  should  be 
applied  to  the  reduction  of  the  principal  in  semi-annual  instal- 
ments"; in  other  words,  that  the  plan  of  repudiating  interest 
obligations  —  since  adopted,  with  no  agreeable  results,  by  Tur- 
key and  Greece  —  should  be  formally  approved  by  the  United 
States.  This  remarkable  utterance  was  first  condemned  by  an 
overwhelming  vote  in  both  House  and  Senate ;  next,  by  an  al- 
most equally  decisive  vote,  on  March  3,  1869,  Congress  adopted 
the  Public  Credit  Act,  promising  coin  redemption  of  both 
notes  and  bonds,  solemnly  pledging  its  faith  "  to  make  pro- 
vision, at  the  earliest  practicable  period,  for  the  redemption 
of  the  United  States  notes  in  coin." 

The  promise  was  as  easily  made  as  the  similar  pledge  of 
December,  1865 ;  was  still  more  easily  broken.  No  such  ar- 
rangement was  made,  nor  any  serious  attempt  in  that  direction, 
until  the  matter  was  forced  on  the  party  by  the  exigency  of 
politics.  Not  only  was  no  effort  made  to  reduce  outstanding 
legal  tenders,  but  the  supply  in  circulation  was  heavily  in- 
creased; rising  from  $314,704,000  in  the  middle  of  1869  to 
$346,168,000  in  1872,  and  two  years  later,  as  a  result  of  the 
Treasury's  weak  experiments  in  the  panic,  to  $371,421,000. 

This  period  was  congenial  to  such  juggling  with  public 
credit  and  legislative  pledges.  Socially,  financially,  and  polit- 
ically, it  stands  out  quite  apart  from  any  other  decade  of  the 
century.  Moral  sense  for  a  time  seemed  to  have  deteriorated 
in  the  whole  community ;  it  was  a  sorry  audience,  at  Washing- 
ton or  elsewhere,  to  which  to  address  appeals  for  economy, 
retrenchment,  and  rigid  preservation  of  the  public  faith.  The 
Government's  financial  recklessness  was  readily  imitated  by  the 
community  at  large;  debt  was  the  order  of  the  day  in  the  af- 
fairs of  both.  As  the  period  approached  its  culmination, 


58  THE  GREENBACKS 

foreign  trade  reflected  the  nature  of  the  situation.  Merchan- 
dise imports  in  the  fiscal  year  1871  rose  $84,000,000  over  1870 ; 
in  1872  they  increased  $106,000,000  over  1871.  This  move- 
ment was  the  familiar  warning  of  an  approaching  crash;  but 
the  warning  fell  on  deaf  ears,  as  it  usually  does.  In  1873  the 
house  of  cards  collapsed. 

The  panic  of  1873  left  the  country's  financial  and  commer- 
cial structure  almost  a  ruin.  It  had,  however,  several  ulterior 
results  so  valuable  that  it  is  not  wholly  unreasonable  to  describe 
the  wreck  o*f  credit  as  a  blessing  in  disguise.  American  prices, 
long  out  of  joint  with  the  markets  of  the  world,  and  thoroughly 
artificial  in  themselves,  were  certain  to  be  eventually  brought 
down.  This  very  liquidating  process  served  a  useful  double 
purpose;  it  disclosed  the  nation's  true  resources,  and  it  placed 
the  United  States  on  equal  footing  with  the  commercial  world 
at  large.  With  the  bursting  of  the  bubble  of  inflated  debt  and 
inflated  prices,  the  excessive  importations  ceased.  Simultane- 
ously the  export  trade,  which  had  halted  during  1872,  in  spite 
of  the  continued  agricultural  expansion,  rose  to  proportions 
never  before  approached  in  our  commercial  history.  In  1874, 
the  balance  of  foreign  trade  turned  permanently  in  our  favor. 
By  1876,  even  the  continuous  outflow  of  gold  was  checked. 
In  short,  the  two  conditions  fixed  by  Hugh  McCulloch,  ten 
years  before,  as  indispensable  to  resumption  of  specie  payments, 
had  now  been  realized. 

Congress  was  not  by  any  means  disposed,  however,  to  seize 
the  opportunity.  The  first  result  of  the  money  market  crisis  in 
1873,  as  in  all  similar  years,  was  urgent  public  clamor  for 
more  currency.  The  Supreme  Court  had  decided  finally,  in 
1871,  for  the  constitutionality  of  the  legal  tenders;  the  Secre- 
tary of  the  Treasury,  in  1873,  had  so  far  yielded  to  the  preva- 
lent excitement  as  to  reissue  legal-tender  notes  already  formally 
retired.  The  first  response  of  Congress,  therefore,  was  an 
inflation  measure.  By  a  vote  of  140  to  102  in  the  House 
of  Representatives,  and  of  29  to  24  in  the  Senate,  a  law  was 
passed  for  the  permanent  increase  of  the  legal-tender  currency, 
by  $18,000,000.  The  Republican  party  controlled  Congress 
by  unusually  large  majorities ;  but  60  per  cent,  of  the  party's 
vote  in  each  chamber  was  cast  in  favor  of  the  bill.  Only  the 


RESUMPTION  OF  SPECIE  PAYMENTS  59 

interposition  of  Grant's  Presidential  veto  prevented  this  first 
positive  backward  step  in  the  direction  of  fiat  money. 

It  is  reasonable  to  suppose  that  this  curious  vote  of  the  Ad- 
ministration party,  which  occurred  in  April,  1874,  measured 
the  party's  political  desperation.  They  were  about  to  receive, 
in  the  Congressional  elections,  the  usual  chastisement  experi- 
enced by  a  dominant  party  when  the  people  vote  in  a  period 
of  hard  times;  the  inflation  act  was  an  anchor  thrown  des- 
perately to  windward.  The  experiment  was  in  all  respects  a 
failure.  Even  the  party's  own  State  conventions  failed  to  say 
a  good  word  for  the  inflation  bill,  and  it  gained  no  mitigation 
of  sentence  in  the  November  vote. 

PASSAGE  OF  THE  RESUMPTION  ACT  l 

The  Forty-third  Congress  had  three  months  of  existence 
left  to  it  after  the  vote  of  November,  1874.  Already  defeated 
overwhelmingly  at  the  polls,  it  had  nothing  to  risk  by  a  move 
in  sound-money  legislation,  and  possibly  much  to  gain.  It 
used  this  three-months'  period  to  enact  a  law  of  the  first  im- 
portance, not  only  to  the  nation,  but  to  the  Republican  party's 
future  history  —  a  law  which  must  fairly  be  described,  how- 
ever, under  the  circumstances  of  the  time,  as  an  expression  of 
death-bed  repentance.  This  was  the  Specie-Resumption  Act, 
drawn  up  by  a  party  committee,  and  submitted  to  Congress,  in 
December,  1874,  by  Senator  John  Sherman.  It  fixed  the  date 
for  resumption  of  specie  payments  at  January  i,  1879,  Pro" 
vided  for  the  reduction  of  legal-tender  notes  from  $382,000,- 
ooo  to  $300,000,000,  but  made  no  provision  for  any  further 
retirement  of  the  notes.  It  went  through  Congress  on  Jan- 
uary 7,  1875.  It  was  contended  by  some  that  under  the  Re- 
sumption Act  of  1875  there  could  be  no  reissue  of  the  green- 
backs once  received  into  the  Treasury.  Inflationist  successes 
of  1877-1878  settled  this  uncertainty,  as  Congress,  May  31, 
1878,  ordered  that  there  be  no  further  destruction  of  green- 
backs. The  amount  then  outstanding  was  $346,681,000  —  the 
volume  of  legal  tenders  still  current. 

1  Ibid.,  pp.  21-22. 


60  THE  GREENBACKS 

THE  STRUGGLE  FOR  RESUMPTION  1 

The  Resumption  Act  is  one  of  the  most  curious  laws  in 
financial  history.  It  was  plain  in  its  requirement  that  on  and 
after  January  i,  1879,  the  Treasury  should  "redeem  in  coin 
the  United  States  legal-tender  notes  then  outstanding,  on  their 
presentation  for  redemption  " ;  but  it  left  the  Treasury  to  make 
whatever  arrangements  it  might  choose.  The  law,  it  is  true, 
conferred  ample  powers.  In  order  "  to  prepare  and  provide 
for  the  redemption  in  this  Act  authorized  or  required,"  it  em- 
powered the  Secretary  of  the  Treasury  "  to  use  any  surplus 
revenues,  from  time  to  time,  in  the  Treasury  not  otherwise  ap- 
propriated, and  to  issue,  sell,  and  dispose  of  bonds  of  the  United 
States  at  not  less  than  par  in  coin.  This  power  was  perpetual. 

The  Law  of  1875  involved  the  double  problem  of  providing 
for  resumption  at  the  stipulated  date,  and  of  maintaining  it 
afterward.  It  is  the  first  of  these  undertakings,  which  we  shall 
now  sketch.  There  were,  as  we  have  already  seen,  two  in- 
fluences at  work  in  1875,  which  made  possible  the  achievement 
as  it  would  not  have  been  in  1866.  These  influences  —  the 
shifting  of  the  foreign  trade  balance  in  favor  of  the  United 
States  and  the  subsequent  check  to  gold  exports  —  were  factors 
on  which  no  finance  minister  could  have  reckoned.  Both  in 
fact  developed  after  the  passage  of  the  Resumption  Law.  But 
even  after  allowing  for  these  accidental  commercial  advantages, 
the  credit  for  the  return  to  specie  payments  on  January  i,  1879, 
belongs  individually  and  without  dispute  to  John  Sherman. 

As  one  of  the  authors  of  the  Resumption  Act,  Mr.  Sherman 
was  responsible  both  for  its  virtues  and  its  vices.  His  appoint- 
ment to  the  Treasury,  therefore,  in  the  Administration  under 
which  resumption  must  by  law  be  carried  out,  was  entirely 
logical.  Yet  the  practical  efficiency  of  Mr.  Sherman,  in  an 
administrative  office,  could  not  then  have  been  foretold.  The 
Secretary's  previous  career,  though  useful  and  industrious,  had 
been  marred  by  weaknesses  which  did  not  promise  well.  As 
a  legislator,  he  belonged  to  the  school  of  compromisers  who 
have  indirectly  been  responsible,  in  a  score  of  critical  emer- 
gencies, for  the  gravest  mischief  in  our  history. 

1Ibid.,  pp.  23-31. 


RESUMPTION  OF  SPECIE  PAYMENTS  6l 

But  Mr.  Sherman  was  not  the  first  of  public  men  to  show 
that  the  faults  or  weakness  of  a  legislator,  whose  purpose  is 
to  obtain  enactment  of  a  policy,  will  sometimes  disappear  in 
the  administrator,  who  presses  settled  policies  into  execution. 
As  Secretary  he  was  unwavering  in  pursuit  of  the  resumption 
goal;  practical,  resolute,  and  adroit  in  the  means  employed. 
It  was  in  the  face  of  the  repudiation  clamor  that  he  declared 
officially  for  payment  of  the  Government  bonds  in  gold. 
Equally  distinct  was  the  Secretary's  public  declaration  that  the 
Act  of  1875  conferred  the  power  to  issue  bonds  after,  as  well 
as  before,  resumption ;  another  precedent  which  did  invaluable 
service  sixteen  years  afterward. 

To  say  that  Secretary  Sherman's  management  of  the  Treas- 
ury achieved  during  his  time  precisely  the  results  proposed,  and 
achieved  them  promptly,  is  to  concede  his  administration's 
practical  success.  Nor  were  these  results  attained  through  ex- 
travagance or  waste.  In  his  refunding  and  resumption  opera- 
tions, Mr.  Sherman  placed  the  bonds  of  the  United  States  on 
better  terms  than  any  of  his  predecessors. 

ARRANGEMENTS  FOR  RESUMPTION  * 

The  Secretary  of  the  Treasury  now  put  the  final  touches  on 
his  arrangements  for  resumption.  Partly  by  accident  and 
partly  through  stress  of  circumstances,  the  Treasury  gold  re- 
serve was  defined,  in  later  years,  at  a  fixed  and  arbitrary  mini- 
mum. The  theory  adopted  by  Mr.  Sherman,  however,  in  his 
early  operations,  was  different  and  undoubtedly  better.  Fol- 
lowing probably  the  practice  of  the  Bank  of  England,  he  fixed 
his  reserve  at  40  per  cent,  of  outstanding  notes  — "  the 
smallest  reserve,"  he  wrote  to  Congress,  "  upon  which  resump- 
tion could  be  prudently  commenced  and  successfully  main- 
tained." On  this  basis  he  held  in  the  Treasury,  on  December 
31,  1878,  $114.193,000  gold  in  excess  of  outstanding  gold 
certificates,  which  was  a  trifle  over  40  per  cent,  of  the  Gov- 
ernment notes  then  circulating  outside  the  Treasury.  Of  this 
gold  reserve,  $95,500,000  had  been  obtained  through  sale  of 
bonds,  part  of  the  coin  being  procured  in  Europe. 

1  Ibid.,  pp.  44-47. 


62  THE  GREENBACKS 

There  remained  now  to'be  settled  only  the  formal  machin- 
ery of  exchange  between  the  Treasury  and  outside  institutions. 
If  the  Treasury  had  left  the  banks  to  pursue  unchanged  their 
policy  of  keeping  special  gold  deposits,  the  Government  reserve 
would  have  been  at  once  imperilled.  If  the  banks  had  con- 
tinued to  present  their  individual  drafts  for  redemption  across 
the  counter  of  the  Sub-Treasury,  any  timid  or  blundering 
banker  might  have  started  a  general  drain  of  gold.  Against 
these  possibilities  Mr.  Sherman  now  took  measures.  He  se- 
cured the  admission  of  the  New  York  Sub-Treasury  as  a  mem- 
ber of  the  clearing-house.  At  New  York  and  Boston  the 
clearing-houses  modified  their  rules,  agreed  to  abolish  "  gold 
deposits  "  after  January  ist,  and  to  accept  the  legal  tenders 
freely  in  discharge  of  balances  against  one  another  and  against 
the  Government.  At  the  same  time,  the  requirement  of  coin 
payment  of  customs  duties  was  revoked,  and  public  officers 
were  directed  to  receive  coin  or  legal  tenders  at  the  payer's 
option  —  a  move  of  obvious  propriety,  since  refusal  to  take 
notes  in  payment  would  merely  send  the  importer  to  the  Treas- 
ury's redemption  office  to  convert  them  into  coin.  All  these 
preliminaries  had  been  formally  and  positively  settled  before 
the  close  of  1878.  On  December  I7th,  the  premium  on  gold 
disappeared,  for  the  first  time  since  1861 ;  on  January  ist, 
specie  payments  were  quietly  resumed. 

SHOULD  THE  GREENBACKS  BE  RETIRED? 

1  Let  us  now  consider  for  a  moment  an  issue  which  twenty 
years  ago  was  urgently  pertinent,  was  in  fact  the  very  crux  of 
so-called  "  currency  reform,"  and  which  still  persists  as  a  live 
issue  in  the  minds  of  some  of  the  veteran  "  reformers  "  of 
those  days,  although  the  conditions  which  then  gave  it  point 
have  long  since  disappeared. 

In  the  middle  nineties,  when  it  was  estimated  that  the  total 
gold  stock  of  the  entire  country  was  only  about  600  million 
dollars  and  less  than  200  millions  of  this  was  in  the  vaults  of 

1  A.  Piatt  Andrew,  The  Essential  and  the  Unessential  in  Currency  Legis- 
lation, in  Questions  of  Public  Policy,  Addresses  delivered  in  the  Page 
Lecture  Series,  1913,  before  the  Senior  Class  of  the  Sheffield  Scientific 
School,  Yale  University,  pp.  55-59.  Yale  University  Press,  New  Haven, 
Connecticut.  1913. 


RETIREMENT  63 

the  treasury,  the  Government's  fiduciary  currency,  consisting 
of  346  millions  of  greenbacks  and  400  millions  or  more  of 
overvalued  silver,  presented  beyond  question  a  serious  menace 
to  the  country's  monetary  standard.  It  meant  that  the  treas- 
ury had  outstanding  currency  obligations  payable  in  gold  to 
the  extent  of  three  or  four  times  its  own  gold  holdings,  and 
amounting  to  far  more  than  all  of  the  gold  in  the  country,  in- 
cluding the  holdings  of  the  treasury,  the  banks,  and  the  general 
public.  At  that  time  fluctuations  in  the  trade  balance  of  a 
single  year  sometimes  almost  equalled  the  treasury's  gold  hold- 
ings in  amount,  and  it  was  quite  conceivable,  in  fact  not 
improbable,  that  a  sudden  unfavorable  change  in  that  balance 
might  drain  the  treasury  of  all  of  its  gold,  and  leave  the 
country  with  a  currency  standard  of  depreciated  silver  or  paper. 
This  was  the  situation  which  continually  menaced  Mr.  Cleve- 
land's second  administration,  causing  great  financial  anxiety 
and  forcing  the  treasury  during  those  years  of  peace  and  normal 
expenditures  to  borrow  262  million  dollars  in  gold  in  order  to 
replenish  its  continually  dwindling  reserve.  Such  a  situation 
inevitably  led  the  advocates  of  monetary  legislation  in  the 
nineties  to  place  first  and  foremost  among  their  proposals  the 
necessity  of  getting  rid  of  the  precarious  greenback,  and  most 
of  the  plans  proposed  by  bankers'  associations,  chambers  of 
commerce,  and  financial  experts  generally  at  that  time  empha- 
sized the  urgency  of  this  measure. 

WHY   RETIREMENT   IS   NOT  IMPORTANT 

It  sometimes  happens  that,  with  the  lapse  of  time  and  with 
changed  conditions,  infirmities,  long  left  untreated,  cure  them- 
selves, and  so  it  has  been  with  the  one-time  bothersome  green- 
back. Twenty  years  ago,  when  the  outstanding  greenbacks 
amounted  to  twice  the  gold  holdings  of  the  treasury  and  to 
much  more  than  half  of  the  country's  entire  gold  stock,  there 
was  abundant  reason  for  anxiety  on  account  of  their  continued 
circulation.  The  situation  is  utterly  different  to-day.  Gold 
has  accumulated  in  the  treasury  beyond  the  wildest  "  dreams  of 
avarice  "  of  the  nineties.  From  less  than  200  millions  in  the 
middle  nineties  the  treasury's  gold  holdings  have  grown  to 
approximately  1,250  millions  to-day,  and  the  estimated  gold 


64  THE  GREENBACKS 

stock  of  the  country  has  increased  from  600  to  more  than  1,800 
millions,  despite  the  fact  that  the  Director  of  the  Mint  in  1907 
reduced  the  estimate  for  gold  in  circulation  by  135  millions  as 
compared  with  the  basis  of  previous  years. 

The  greenback  has  thus  become  each  year  a  relatively  less 
important  element  in  our  currency  system,  an  element  of  ever 
less  and  less  potency  for  harm.  Doubtless  the  absolute  amount 
of  outstanding  greenbacks  has  diminished  considerably  through 
loss  and  destruction  during  fifty  years,  and  is  to-day  far  less 
than  the  $346,000,000  issued  during  the  Civil  War,  which  are 
still  carried  as  an  obligation  on  the  Government  books.  .  .  . 

The  greenbacks  are  less  menacing  to-day  for  the  further  rea- 
son that  they  are  being  rapidly  transformed  into  small  de- 
nominations which  are  absorbed  in  the  general  circulation,  and 
which  could  only  with  great  difficulty  be  collected  in  suffi- 
ciently large  amounts  to  cause  a  serious  drain  upon  the  treas- 
ury through  presentation  for  redemption.  ...  So  great  and 
continuous  is  the  demand  for  notes  of  small  denominations  that 
one  may  safely  predict  that  in  another  decade  practically  all 
of  the  greenbacks  still  in  existence  will  be  in  small  denomina- 
tions in  the  pockets  of  the  people. 

The  "  endless  chain "  with  its  ineffectual  bond  issues,  the 
imminence  of  specie  suspension,  and  the  fear  of  treasury  bank- 
ruptcy will  never  again  result  from  the  outstanding  greenbacks. 
Their  dangers,  lurid  and  nerve-racking  though  they  were 
twenty  years  ago,  are  now  only  memories. 

THE  CONFEDERATE  CURRENCY  * 

The  financial  system  adopted  by  the  Confederate  Government 
was  singularly  simple  and  free  from  technicalities.  It  con- 
sisted chiefly  in  the  issue  of  treasury  notes  enough  to  meet  all 
the  expenses  of  the  Government,  and  in  the  present  advanced 
state  of  the  art  of  printing  there  was  but  one  difficulty  incident 
to  this  process ;  namely,  the  impossibility  of  having  the  notes 
signed  in  the  Treasury  Department,  as  fast  as  they  were  needed. 
There  happened,  however,  to  be  several  thousand  young  ladies 
in  Richmond  willing  to  accept  light  and  remunerative  employ- 

1  Adapted  from  George  Gary  Eggleston,  A  Rebel's  Recollections,  pp. 
78-107.  Kurd  and  Houghton.  Boston,  1875. 


CONFEDERATE  CURRENCY  65 

ment  at  their  homes,  and  as  it  was  really  a  matter  of  small 
moment  whose  name  the  notes  bore,  they  were  given  out  in 
sheets  to  these  young  ladies,  who  signed  and  returned  them 
for  a  consideration.  I  shall  not  undertake  to  guess  how  many 
Confederate  treasury  notes  were  issued.  Indeed,  I  am  credibly 
informed  by  a  gentleman  who  was  high  in  office  in  the  Treasury 
Department,  that  even  the  Secretary  himself  did  not  certainly 
know.  It  was  clearly  out  of  the  power  of  the  Government 
ever  to  redeem  the  notes,  and  whatever  may  have  been  the 
state  of  affairs  within  the  treasury,  nobody  outside  its  pre- 
cincts ever  cared  to  muddle  his  head  in  an  attempt  to  get  at 
exact  figures. 

We  knew  only  that  money  was  astonishingly  abundant. 
Provisions  fell  short  sometimes,  and  the  supply  of  clothing 
was  not  always  as  large  as  we  should  have  liked,  but  nobody 
found  it  difficult  to  get  money  enough.  It  was  to  be  had  almost 
for  the  asking.  And  to  some  extent  the  abundance  of  the 
currency  really  seemed  to  atone  for  its  extreme  badness. 
Money  was  so  easily  got,  and  its  value  was  so  utterly  uncertain, 
that  we  were  never  able  to  determine  what  was  a  fair  price  for 
anything.  We  fell  into  the  habit  of  paying  whatever  was 
asked,  knowing  that  to-morrow  we  should  have  to  pay  more. 

Speculation  became  the  easiest  and  surest  thing  imaginable. 
The  speculator  saw  no  risks  of  loss.  Every  article  of  merchan- 
dise rose  in  value  every  day,  and  to  buy  anything  this  week 
and  sell  it  next  was  to  make  an  enormous  profit  quite  as  a 
matter  of  course.  So  uncertain  were  prices,  or  rather  so  con- 
stantly did  they  tend  upward,  that  when  a  cargo  of  cadet  gray 
cloths  was  brought  into  Charleston  once,  an  officer  in  my 
battery,  attending  the  sale,  was  able  to  secure  enough  of  the 
cloth  to  make  t\vo  suits  of  clothes,  without  any  expense  what- 
ever, merely  by  speculating  upon  an  immediate  advance. 
Naturally  enough,  speculation  soon  fell  into  very  bad  repute, 
and  the  epithet  "  speculator  "  came  to  be  considered  the  most 
.opprobrious  in  the  whole  vocabulary  of  invective.  The  feel- 
ing was  universal  that  the  speculators  were  fattening  upon  the 
necessities  of  the  country  and  the  sufferings  of  the  people. 
Nearly  all  mercantile  business  was  regarded  at  least  with 
suspicion,  and  much  of  it  fell  into  the  hands  of  people  with  no 


66  THE  GREENBACKS 

reputations  to  lose,  a  fact  which  certainly  did  not  tend  to 
relieve  the  community  in  the  matter  of  high  prices. 

The  prices  which  obtained  were  almost  fabulous,  and  singu- 
larly enough  there  seemed  to  be  no  sort  of  ratio  existing  be- 
tween the  values  of  different  articles.  I  bought  coffee  at  forty 
dollars  and  tea  at  thirty  dollars  a  pound  on  the  same  day.  My 
dinner  at  a  hotel  cost  me  twenty  dollars,  while  five  dollars 
gained  me  a  seat  in  the  dress  circle  of  the  theatre.  I  paid  one 
dollar  the  next  morning  for  a  copy  of  the  Examiner,  but  I 
might  have  got  the  Whig,  Dispatch,  Enquirer,  or  Sentinel,  for 
half  that  sum.  For  some  wretched  tallow  candles  I  paid  ten 
dollars  a  pound.  The  utter  absence  of  proportion  between 
these  several  prices  is  apparent,  and  I  know  of  no  way  of 
explaining  it  except  upon  the  theory  that  the  unstable  character 
of  the  money  had  superinduced  a  reckless  disregard  of  all 
value  on  the  part  of  both  buyers  and  sellers.  A  facetious 
friend  used  to  say  prices  were  so  high  that  nobody  could  see 
them,  and  that  they  "  got  mixed  for  want  of  supervision."  He 
held,  however,  that  the  difference  between  the  old  and  the  new 
order  of  things  was  a  trifling  one.  "  Before  the  war,"  he 
said,  "  I  went  to  market  with  the  money  in  my  pocket,  and 
brought  back  my  purchases  in  a  basket ;  now  I  take  the  money 
in  the  basket,  and  bring  the  things  home  in  my  pocket." 

As  I  was  returning  to  my  home  after  the  surrender  at  Ap- 
pomattox  Court  House,  a  party  of  us  stopped  at  the  residence 
of  a  planter  for  supper,  and  as  the  country  was  full  of  ma- 
rauders and  horse  thieves,  deserters  from  both  armies,  bent 
upon  indiscriminate  plunder,  our  host  set  a  little  black  boy  to 
watch  our  horses  while  we  ate,  with  instructions  to  give  the 
alarm  if  anybody  should  approach.  After  supper  we  dealt 
liberally  with  little  Sam.  Silver  and  gold  we  had  none,  of 
course,  but  Confederate  money  was  ours  in  great  abundance, 
and  we  bestowed  the  crisp  notes  upon  the  guardian  of  our 
horses,  to  the  extent  of  several  hundreds  of  dollars.  A  richer 
person  than  that  little  negro  I  have  never  seen.  Money,  even 
at  par,  never  carried  more  of  happiness  with  it  than  did  those 
promises  of  a  dead  government  to  pay.  We  frankly  told  Sam 
that  he  could  buy  nothing  with  the  notes,  but  the  information 
brought  no  sadness  to  his  simple  heart. 


CONFEDERATE  CURRENCY  67 

"  I  don'  want  to  buy  nothin',  master,"  he  replied.  "  I's 
gwine  to  keep  dis  always." 

I  fancy  his  regard  for  the  worthless  paper,  merely  because 
it  was  called  money,  was  closely  akin  to  the  feeling  which  had 
made  it  circulate  among  better-informed  people  than  he. 
Everybody  knew,  long  before  the  surrender,  that  these  notes 
never  could  be  redeemed.  There  was  little  reason  to  hope, 
during  the  last  two  years  of  the  war,  that  the  "  ratification  of  a 
treaty  of  peace  between  the  Confederate  States  and  the  United 
States,"  on  which  the  payment  was  conditioned,  would  ever 
come.  We  knew  the  paper  was  worthless,  and  yet  it  con- 
tinued to  circulate.  It  professed  to  be  money,  and  on  the 
strength  of  that  profession  people  continued  to  take  it  in  pay- 
ment for  goods.  The  amount  of  it  for  which  the  owner  of 
any  article  would  part  with  his  possession  was  always  uncer- 
tain. Prices  were  regulated  largely  by  accident,  and  were 
therefore  wholly  incongruous. 

In  the  winter  of  1863-64  Congress  became  aware  of  the 
fact  that  prices  were  higher  than  they  should  be  under  a  sound 
currency.  If  Congress  suspected  this  at  any  earlier  date, 
there  is  nothing  in  the  proceedings  of  that  body  to  indicate  it. 
Now,  however,  the  newspapers  were  calling  attention  to  an 
uncommonly  ugly  phase  of  the  matter,  and  reminding  Congress 
that  what  the  Government  bought  with  a  currency  depreciated 
to  less  than  one  per  cent,  of  its  face,  the  Government  must 
some  day  pay  for  in  gold  at  par.  The  lawgivers  took  the 
alarm  and  sat  themselves  down  to  devise  a  remedy  for  the  evil 
condition  of  affairs.  With  that  infantile  simplicity  which 
characterized  nearly  all  the  doings  and  quite  all  the  financial 
legislation  of  the  Richmond  Congress,  it  was  decided  that  the 
very  best  way  to  enhance  the  value  of  the  currency  was  to 
depreciate  it  still  further  by  a  declaratory  statute,  and  then  to 
issue  a  good  deal  more  of  it.  The  act  set  a  day,  after  which 
the  currency  already  in  circulation  should  be  worth  only  two- 
thirds  of  its  face,  at  which  rate  it  was  made  convertible  into 
notes  of  the  new  issue,  which  some,  at  least,  of  the  members 
of  Congress  were  innocent  enough  to  believe  would  be  worth 
very  nearly  their  par  value.  This  measure  was  intended,  of 
course,  to  compel  the  funding  of  the  currency,  and  it  had  that 


68  THE  GREENBACKS 

effect  to  some  extent,  without  doubt.  Much  of  the  old  cur- 
rency remained  in  circulation,  however,  even  after  the  new 
notes  were  issued.  For  a  time  people  calculated  the  discount, 
in  passing  and  receiving  the  old  paper,  but  as  the  new  notes 
showed  an  undiminished  tendency  to  still  further  depreciation, 
there  were  people,  not  a  few,  who  spared  themselves  the 
trouble  of  making  the  distinction. 

I  am  sometimes  asked  at  what  time  prices  attained  their 
highest  point  in  the  Confederacy,  and  I  find  that  memory  fails 
to  answer  the  question  satisfactorily.  They  were  about  as 
high  as  they  could  be  in  the  fall  of  1863,  and  I  should  be 
disposed  to  fix  upon  that  as  the  time  when  the  climax  was 
reached,  but  for  my  consciousness  that  the  law  of  constant  de- 
preciation was  a  fixed  one  throughout  the  war.  The  financial 
condition  got  steadily  worse  to  the  end. 

The  Government's  course  in  levying  a  tax  in  kind,  as  the  only 
possible  way  of  making  the  taxation  amount  to  anything,  led 
speedily  to  the  adoption  of  a  similar  plan,  as  far  as  possible, 
by  the  people.  A  physician  would  order  from  his  planter 
friend  ten  or  twenty  visits'  worth  of  corn,  and  the  transaction 
was  a  perfectly  intelligible  one  to  both.  The  visits  would  be 
counted  at  ante-war  rates,  and  the  corn  estimated  by  the  same 
standard.  In  the  early  spring  of  1865  I  wanted  a  horse,  and 
a  friend  having  one  to  spare,  I  sent  for  the  animal,  offering  to 
pay  whatever  the  owner  should  ask  for  it.  He  could  not  fix  a 
price,  having  literally  no  standard  of  value  to  which  he  could 
appeal,  but  he  sent  me  the  horse,  writing,  in  reply  to  my  note : 

"  Take  the  horse,  and  when  the  war  shall  be  over,  if  we  are 
both  alive  and  you  are  able,  give  me  as  good  a  one  in  return. 
Don't  send  any  note  or  due-bill.  It  might  complicate  matters 
if  either  should  die." 

A  few  months  later  I  paid  my  debt  by  returning  the  very 
horse  I  had  bought.  I  give  this  incident  merely  to  show  how 
utterly  without  financial  compass  or  rudder  we  were. 

How  did  people  manage  to  live  during  such  a  time?  I  am 
often  asked ;  and  as  I  look  back  at  the  history  of  those  years, 
I  can  hardly  persuade  myself  that  the  problem  was  solved  at  all. 
A  large  part  of  the  people,  however,  was  in  the  army,  and  drew 
rations  from  the  Government.  The  country  people  raised  upon 


CONFEDERATE  CURRENCY  69 

their  plantations  all  the  necessaries  of  life,  and  were  generally 
allowed  to  keep  enough  of  them  to  live  on,  the  remainder  being 
taken  by  the  subsistence  officers  for  army  use. 

In  the  cities,  living  was  not  by  any  means  so  easy  as  in  the 
country.  Business  was  paralyzed,  and  abundant  as  money  was, 
it  seems  almost  incredible  that  city  people  got  enough  of  it  to 
live  on.  Very  many  of  them  were  employed,  however,  in 
various  capacities,  in  the  arsenals,  departments,  bureaus,  etc., 
and  these  were  allowed  to  buy  rations  at  fixed  rates,  after  the 
postoffice  clerks  in  Richmond  had  brought  matters  to  a  crisis 
by  resigning  their  clerkships  to  go  into  the  army,  because  they 
could  not  support  life  on  their  salaries  of  nine  thousand  dollars 
a  year.  For  the  rest,  if  people  had  anything  to  sell,  they  got 
enormous  prices  for  it,  and  could  live  a  while  on  the  proceeds. 
Above  all,  a  kindly,  helpful  spirit  was  developed  by  the  common 
suffering,  and  this,  without  doubt,  kept  many  thousands  of 
people  from  starvation.  Nobody  formed  any  plans  or  laid  by 
any  money  for  to-morrow  or  next  week  or  next  year,  and 
indeed  to  most  of  us  there  really  seemed  to  be  no  future.  We 
were  not  used  to  think  of  ourselves  as  possible  survivors  of  a 
struggle  which  was  every  day  perceptibly  thinning  our  ranks. 
The  coming  of  ultimate  failure  we  saw  clearly  enough,  but  the 
future  beyond  was  a  blank. 

The  reader  may  find  it  difficult  to  believe  that  with  gold  at 
a  hundred  and  twenty-five  for  one,  or  12,400  per  cent,  pre- 
mium ;  when  every  day  made  the  hopelessness  of  the  struggle 
more  apparent ;  when  our  last  man  was  in  the  field ;  when  the 
resources  of  the  country  were  visibly  at  an  end,  there  were 
financial  theorists  who  honestly  believed  that  by  a  mere  trick 
of  legislation  the  currency  could  be  brought  back  to  par.  I 
heard  some  of  these  people  explain  their  plan  during  a  two  days' 
stay  in  Richmond.  Gold,  they  said,  is  an  inconvenient  cur- 
rency always,  and  nobody  wants  it,  except  as  a  basis.  The 
Government  has  some  gold  —  several  millions  in  fact  —  and  if 
Congress  will  only  be  bold  enough  to  declare  the  treasury 
notes  redeemable  at  par  in  coin,  we  shall  have  no  further  diffi- 
culty with  our  finances.  So  long  as  notes  are  redeemable  in 
gold  at  the  option  of  the  holder,  nobody  wants  them  re- 
deemed. .  .  .  The  gold  which  the  Government  holds  will 


70  THE  GREENBACKS 

suffice  to  satisfy  a  few  timid  ones,  and  there  will  be  an  end  of 
high  prices  and  depreciated  currency.  I  am  not  jesting.  This 
is,  as  nearly  as  I  can  repeat  it,  the  utterance  of  a  member  of 
the  Confederate  Congress. 

The  matter  of  prices  was  frequently  made  a  subject  for  jest- 
ing in  private,  but  for  the  most  part  it  was  carefully  avoided  in 
the  newspapers.  As  with  the  accounts  of  battles  in  which  our 
arms  were  not  successful,  necessary  references  to  the  condition 
of  the  finances  were  crowded  into  a  corner,  as  far  out  of  sight 
as  possible.  The  Examiner,  however,  on  one  occasion  de- 
nounced with  some  fierceness  the  charges  prevailing  in  the 
schools ;  and  I  quote  a  passage  from  Prof.  Sidney  H.  Owens's 
reply,  which  is  interesting  as  a  summary  of  the  condition  of 
things  in  the  South  at  that  time : 

"  The  charges  made  for  tuition  are  about  five  or  six  times  as 
high  as  in  1860.  Now,  sir,  your  shoemaker,  carpenter, 
butcher,  market  man,  etc.,  demand  from  twenty,  to  thirty,  to 
forty  times  as  much  as  in  1860.  Will  you  show  me  a  civilian 
who  is  charging  only  six  times  the  prices  charged  in  1860, 
except  the  teacher  only?  As  to  the  amassing  of  fortunes  by 
teachers,  spoken  of  in  your  article,  make  your  calculations, 
sir,  and  you  will  find  that  to  be  almost  an  absurdity,  since  they 
pay  from  twenty  to  forty  prices  for  everything  used,  and  are 
denounced  exorbitant  and  unreasonable  in  demanding  five  or 
six  prices  for  their  own  labor  and  skill !  " 

There  were  compensations,  however.  When  gold  was  at 
12,000  per  cent,  premium  with  us,  we  had  the  consolation  of 
knowing  that  it  was  in  the  neighborhood  of  one  hundred  above 
par  in  New  York,  and  a  Richmond  paper  of  September  22, 
1864,  now  before  me,  fairly  chuckles  over  the  high  prices  pre- 
vailing at  the  North,  in  a  two-line  paragraph  which  says,  "  Tar 
is  selling  in  New  York  at  two  dollars  a  pound.  It  used  to  cost 
eighty  cents  a  barrel."  That  paragraph  doubtless  made  many 
a  five-dollar  beefsteak  palatable. 


CHAPTER  VI 
INTERNATIONAL  BIMETALLISM 

*.  .  .  THERE  are  natural  and  commercial  causes  which  may 
operate  to  produce  either  an  incessant  fluctuation  in  the 
relative  value  of  silver  and  gold,  or  a  wide  and  increasing 
divergence,  from  year  to  year,  through  a  long  period,  from  the 
ratio  of  exchange  existing  between  the  two  metals  at  the  com- 
mencement of  the  period.  So  far  are  the  sources  and  condi- 
tions of  supply  of  the  one  different  from  those  of  the  other 
that,  notwithstanding  the  influence  of  the  durableness  of  the 
metals  in  giving  steadiness  of  value  to  either  by  turns,  and 
hence  to  the  two  in  their  relation  to  each  other,  it  would  be  in 
the  highest  degree  unreasonable  to  assume  that  the  ratio  of 
exchange  between  gold  and  silver  would  remain  unaltered 
through  any  considerable  term  of  years.  The  annual  or 
monthly  variations  may  take  the  form  of  oscillations,  now  on 
one  side  and  now  on  the  other  of  any  historical  ratio,  or  they 
may  be  cumulative  on  one  side  of  that  ratio,  producing  a 
divergence  increasing  from  month  to  month,  and  year  to 
year;  but  variations  in  some  degree,  in  some  direction,  are 
to  be  expected  under  the  unrestrained  operation  of  causes  in- 
fluencing the  demand  for,  or  the  supply  of,  each  metal. 

The  conditions,  natural  and  commercial,  which  determine 
the  ratio  of  exchange  of  the  two  metals  being  such,  we  have 
seen  that  government  may  enter,  and,  by  making  the  two  in- 
differently legal  tender  for  debts  at  a  ratio  fixed  by  law,  may, 
for  the  time,  counteract  the  operation  of  any  and  all  forces 
tending  to  produce  divergence.  So  long  as  any  country 
establishing  such  a  principle  holds  a  considerable  amount  of 
that  metal  which,  under  the  natural  and  commercial  condi- 
tions of  supply  and  demand  prevailing  at  the  time,  tends  to 

1  Francis  A.  Walker,  Money  in  Its  Relations  to   Trade  and  Industry, 
pp.  164-176;  178-182.     Henry  Holt  &  Company.     New  York.     1889. 

71 


72  BIMETALLISM 

become  the  dearer  of  the  two,  it  is  impossible  that  the  cheap- 
ened metal  should  there,  or  in  any  market,  fall  far  below  that 
ratio.  By  the  force  of  the  bimetallic  law,  the  substitution  of 
the  cheapened  for  the  dearer  metal  will  at  once  begin;  and 
so  long  as  that  continues,  the  divergence  of  the  market  ratio 
from  the  mint  ratio  can  never  be  wide.  Why  should  any  one 
in  London  or  New  York  pay  much  more  than  fifteen  and  a 
half  ounces  of  silver  for  an  ounce  of  gold,  when  gold  can,  at 
any  time  and  in  any  amount,  be  obtained  for  silver  at  the  rate 
of  fifteen  and  a  half  in  Paris? 

This  operation  of  the  bimetallic  system  can  not  be  denied; 
but  there  is  ground  for  dispute  as  to  the  degree  of  the  ad- 
vantages to  result,  and  as  to  the  cost  at  which  those  advantages 
are  to  be  obtained.  The  monometallist,  or  advocate  of  the 
so-called  single  standard,  is  disposed  to  disparage  the  benefits 
to  be  expected,  and  to  magnify  the  expense  of  this  system. 
He  points  to  the  fact  that  the  two  metals  do  not  actually  cir- 
culate in  the  same  country,  at  the  same  time,  in  any  consider- 
able degree ;  that  it  is  always  the  one  metal  or  the  other  which 
is  used  as  money,  according  as  the  market  ratio  diverges  to 
the  one  side  or  the  other  of  the  mint  ratio,  while  the  coin  made 
from  the  dearer  metal  acquires  a  premium,  and  is  exported  or 
hoarded.  Hence  it  is  said  bimetallism  really  means  the  use 
of  but  one  metal  in  a  country  at  a  time.  It  is  not  a  double 
standard,  but  an  alternate  standard. 

To  this  the  bimetallist  replies  that  the  concurrent  use  of  the 
two  money  metals,  side  by  side,  in  the  same  markets,  is  a 
matter  wholly  of  indifference.  The  merit  of  the  bimetallic 
scheme  does  not  depend  on  this  at  all. 

The  object  of  bimetallism  is,  by  joining  the  two  metals  to- 
gether in  the  coinage,  at  a  fixed  ratio,  to  diminish  the  extent 
of  the  fluctuations  to  which  the  value  of  each  would  be 
separately  liable,  by  generating  a  compensatory  action  between 
the  two,  by  which  the  cheapening  metal  shall  receive  a  larger 
use,  while  the  appreciating  metal  drops  partially  out  of  its 
former  demand,  thus  making  the  two  fall  together,  if  there 
must  be  a  fall,  or  rise  together,  in  the  opposite  case :  or,  con- 
ceivably, making  the  tendency  of  one  to  fall  precisely  counter- 
act the  tendency  of  the  other  to  rise. 


PRINCIPLE  ILLUSTRATED  73 

Thus  we  may  suppose  four  successive  cases  to  illustrate  the 
working  of  this  principle. 

The  first  is,  where  the  demand  for  the  use  of  either  metal 
in  trade  remaining  the  same,  a  large  increase  in  the  supply 
of  one  metal,  A,  takes  place,  the  supply  of  the  other,  B, 
remaining  unchanged.  In  this  case,  without  the  bimetallic 
system,  the  value  of  A  would  tend  to  fall  rapidly  through  a 
considerable  space,  while  the  value  of  B  would  stand  fast. 
With  the  bimetallic  system,  the  joint  supply  of  the  two  metals 
would  be  applicable  to  meet  the  joint  demand  for  the  two. 
Now,  as  the  joint  supply  has  been  increased  without  any 
change  in  the  joint  demand,  there  must  be  a  fall  in  value;  but 
the  fall  will  be  in  the  two  indistinguishably,  except  for  a  slight 
degree  of  delay  and  friction  in  exchange.  Both  will  fall,  but 
the  depth  of  the  fall  will  be  diminished  as  the  surface  over 
which  it  is  to  take  place  has  been  enlarged. 

The  second  is  where,  the  demands  of  trade  for  both  metals 
remaining  the  same,  a  diminution  occurs  in  the  supply  of  A, 
while  the  supply  of  B  remains  unchanged.  Here,  by  the  op- 
eration of  the  same  principle,  a  rise  in  the  value  of  money  will 
take  place,  since  the  joint  supply  has  been  reduced  without  any 
corresponding  change  in  the  joint  demand.  The  rise  will  be 
a  rise  of  the  two  metals  indistinguishably,  the  height  of  the 
rise  being  diminished  as  the  surface  over  which  it  is  to  take 
place  has  been  enlarged. 

The  third  case  is  where,  demand  remaining  the  same,  the 
supply  of  both  metals  undergoes  a  change  in  the  same  direc- 
tion, either  of  increase  or  of  diminution,  at  the  same  time.  In 
this  event,  the  fall  or  rise  will  again  be  of  the  two  indis- 
tinguishably, the  point  reached  being  a  mean  between  the 
points  which  would  have  been  reached  by  the  two  severally. 

The  fourth  case  is  where,  demand  remaining  the  same,  the 
supply  of  the  two  metals  undergoes  a  change  at  the  same  time, 
but  in  opposite  directions,  A  through  diminution,  B  through 
increase.  In  this  case,  the  opposite  tendencies  will  counteract 
each  other.  If  of  equal  force,  the  value  of  money  will  be 
stable;  if  of  unequal  force,  there  will  be  movement  in  the 
direction  of  the  stronger  to  the  extent  of  the  difference  be- 
tween the  two.  Instead  of  one  falling  and  the  other  rising 


74  BIMETALLISM 

in  value,  the  change  will  be  wrought  in  the  two  indistinguish- 
ably. 

It  will  appear  from  the  foregoing  statements  that,  under  the 
bimetallic  system,  the  value  of  money  will  be  liable  to  vary 
more  frequently  than  under  the  monometallic  system.  That 
is,  a  change  in  respect  to  either  constituent  of  the  money  mass 
will  produce  a  change  of  value;  and  it  is  apparent  that  the 
chances  of  change  are  greater  with  two  constituents  than  with 
one.  On  the  other  hand,  the  variations  under  the  bimetallic 
system  are  likely  to  be  less  extensive.  Indeed,  it  is  a  matter 
of  practical  certainty  that  they  will  be  far  less  extensive  than 
they  would  be  under  the  monometallic  system,  whichever  metal 
were  adopted  as  the  standard  of  deferred  payments. 

But,  again,  the  monometallist  interposes  the  objection  that 
the  bimetallic  system  is  only  to  be  supported  at  great  expense 
to  the  States  maintaining  it ;  that  they  lose  by  the  exchange  of 
the  dearer  for  the  cheapened  metal,  even  though  they  acquire 
a  certain  premium  in  doing  so,  and  that  sooner  or  later  the 
stock  of  the  dearer  metal  in  the  bimetallic  countries  will  be- 
come exhausted,  and  the  system  will  collapse,  the  price  of  the 
two  metals  no  longer  being  held  closely  or  nearly  at  the 
former  ratio^by  the  possibility  of  exchanging  them  at  that 
ratio,  freely,  in  any  amount. 

How  far  a  bimetallic  country  loses  by  the  alternation  of  the 
metals  in  circulation,  as  now  one  and  now  the  other  becomes 
the  cheaper  at  the  coinage  ratio,  is  a  nice  question. 

That  the  service  rendered  to  the  commerce  of  the  world  by 
establishing  a  normal  price  for  each  metal  in  terms  of  the 
other,  and  thus  creating  and  maintaining  a  par-of -exchange 
between  gold  countries  and  silver  countries,  is  worth  far 
more  than  its  cost,  seems  to  me  beyond  a  rational  doubt.  It 
would,  in  my  view,  be  as  reasonable  to  doubt  whether  London 
Bridge  repays  the  expense  of  its  erection  and  repair.  Were 
the  cost  of  this  bimetallic  service,  whatever  it  is,  properly 
assessed  upon  and  collected  from  each  commercial  nation  of 
the  world  by  turns,  according  to  the  proportion  in  which  it 
derives  advantage  therefrom,  I  think  it  might  safely  be  said 
that  no  one  of  these  nations  would  sustain  a  single  other  charge 
which  so  fully  justified  itself  in  the  return  it  made,  whether 


COST  OF  BIMETALLISM  75 

that  other  charge  were  for  works  of  construction,  for  the  ad- 
ministration of  justice,  or  for  any  other  strictly  necessary 
purpose. 

But  there  is  no  assurance  that  the  cost  of  the  bimetallic  sys- 
tem will  be  thus  equitably  assessed.  If  the  whole  charge  of 
erecting  and  repairing  London  Bridge  were  thrown  upon  the 
merchants  of  the  two  or  three  streets  nearest  thereto,  while 
yet  the  whole  population  were  allowed  to  use  the  bridge,  free 
of  toll,  there  would  not  unnaturally  arise  a  strong  sense  of 
injustice  on  the  part  of  those  who  bore  this  burden  for  the 
public  benefit;  it  might  even  become  a  question  whether  the 
undoubted  advantages  derived  by  them  from  the  'use  of  the 
bridge  repaid  the  disproportionate  expense  which  it  caused 
them.  If  the  maintenance  of  the  bimetallic  system  involves  a 
certain  burden  on  the  nations  which  sustain  it,  as  I  am  disposed 
to  think  is  the  case,  it  fairly  becomes  a  question  whether 
those  individual  nations  are  compensated  for  bearing  the 
whole  expense  of  the  service  by  their  share  of  the  advan- 
tages resulting  therefrom  to  the  trade  and  industry  of  the 
world. 

That  England  could  well  have  afforded,  throughout  the  pres- 
ent century,  to  maintain  this  system  for  her  own  benefit, 
whatever  it  cost,  even  though  other  nations  profited  by  it  in 
greater  or  less  degree,  is  clear  as  the  light.  That  France,  a 
country  of  far  less  extended  international  trade,  has  been  com- 
pensated for  bearing  so  large  a  part  as  she  has  done  of  the 
burden  of  maintaining  a  par-of-exchange  for  the  commerce 
of  the  world,  by  her  share  of  the  resulting  advantages,  I  make 
no  question;  but  it  must  be  admitted  to  be  fairly  a  matter  of 
dispute. 

On  such  a  point  it  is  evidence  of  no  small  value  that  the 
French  people  themselves  and  the  French  statesmen,  though 
singularly  acute  and  sagacious  in  matters  of  finance,  have 
apparently  not  doubted  that  the  bimetallic  system  was  for  the 
interest  of  their  country.  Certain  of  the  French  political 
economists  —  MM.  Chevalier,  Levasseur,  Bonnet,  Mannequin, 
Leroy  Beaulieu —  from  their  theory  of  the  subject  have  held 
that  France  lost  by  her  policy  in  this  respect ;  but  the  financiers 
of  that  remarkable  nation  held  firmly  to  the  "double  stand- 


76  BIMETALLISM 

ard  "  from  1785  to  1874.  And  though  France  at  the  latter 
date  restricted  her  silver  coinage,  and  two  years  later  stopped 
it  altogether,  it  was  not  done  as  the  result  of  any  change  of 
views.  Partly  it  was  from  deference  to  her  monetary  allies, 
Belgium  and  Switzerland,  but  chiefly  because  the  demonetiza- 
tion of  silver  by  Germany  and  the  sale  of  the  discarded  metal 
of  that  empire  brought  a  sudden  strain  upon  the  bimetallic 
system  which  threatened  to  break  it  violently  down.  Hence 
France  closed  her  mints  to  silver,  but  not  with  any  confession 
that  her  policy  had  been  erroneous  under  the  conditions  previ- 
ously existing;  not  from  any  desire  to  abandon  that  policy 
should  the-  future  offer  conditions  which  would  admit  the 
resumption  of  bimetallism.  It  was  the  declaration  of  M. 
Leon  Say,  the  French  Minister  of  Finance,  the  President  of 
the  International  Monetary  Conference  of  1878,  that  France, 
in  suspending  the  coinage  of  silver,  had  taken  no  step  towards 
the  single  gold  standard,  but  had  placed  herself  in  a  position 
to  await  events,  a  position  which  she  would  not  leave  till  good 
reasons  for  action  should  appear,  and  then  most  probably  to  re- 
enter  on  the  system  of  the  double  standard.  .  .  . 

The  objection  that  Ae  stock  of  the  dearer  metal  in  the  bi- 
metallic States  must,  if  the  drain  be  indefinitely  continued,  be- 
come after  a  while  exhausted,  and  that  the  system  will  then 
lose  all  its  efficiency  in  holding  the  two  metals  together,  is 
unquestionably  valid;  but  an  altogether  unreasonable  weight 
has  been  assigned  to  it  in  the  discussion  of  bimetallism  as  a 
scheme  of  practical  statesmanship. 

If  we  look  at  almost  any  treatise  written  from  the  mono- 
metallic point  of  view,  we  shall  find  that  it  is  taken  as  con- 
clusive against  that  scheme,  that  conditions  of  supply  and 
demand  can  be  assumed  for  the  two  metals  separately  which 
would  result  in  the  complete  exhaustion  of  the  dearer  metal, 
and  the  consequent  loss  of  all  virtue  in  the  bimetallic  scheme. 
The  bimetallist  is  confronted  with  a  series  of  adverse  condi- 
tions, taken  each  at  its  maximum  and  piled  one  above  the 
other  without  the  least  regard  to  the  modesty  of  nature,  or 
the  experience  of  the  past;  and  is  then  challenged  to  say 
whether  the  system  he  proposes  could  be  maintained  under 
such  circumstances.  If  he  is  candid  enough  to  admit  that 


COST  OF  BIMETALLISM  77 

bimetallism  would  fail  there,  it -is  taken  for  granted  that  the 
whole  question  is  disposed  of. 

:  Now,  human  institutions  are  not  to  be  judged  of,  and  ap- 
proved or  disapproved,  by  such  methods.  The  folly  of  rea- 
soning like  this  would  be  seen  at  once  were  it  applied  to 
ordinary  political  matters.  No  government  on  earth  could 
stand  against  one- fourth  or  one-tenth  of  the  elements  of 
hostility  which  might  conceivably  be  arrayed  against  it. 
Mankind  do  not,  therefore,  refuse  to  form  governments. 

Bimetallism  is  a  political  institution  for  practical  ends,  and 
is  entitled  to  be  judged  with  reference  to  reasonable  probabili- 
ties. It  may  claim  the  benefit  of  the  chance  that  adverse  con- 
ditions will  be  offset  by  conditions  favourable,  and  that  the 
adverse  conditions  will  not  prove  so  severe  at  the  start  as 
they  may  be  conceived,  and  that  their  force  will  be  more 
quickly  spent  than  might  be  feared. 

It  would  be  perfectly  legitimate  ground  on  which  to  establish 
European  bimetallism,  that  the  French  system,  with  so  little 
of  support  from  other  States,  passed  within  a  quarter  of  a 
century  through  the  three  successive  shocks  of  the  gold  dis- 
coveries of  Siberia,  the  gold  discoveries  of  California,  and 
the  gold  discoveries  of  Australia,  and  yet  was  not  brought  to 
the  ground. 

With  Germany,  France,  and  England  joined  in  a  monetary 
union,  no  changes  reasonably  to  be  anticipated  in  the  condi- 
tions of  supply  of  the  one  metal  or  the  other  would  succeed 
in  moving  the  market  ratio  far  apart  from  the  mint  ratio 
thus  supported  by  maintaining  over  so  wide  a  surface  a  legal 
equivalence  between  the  two  metals  in  payment  of  debts. 

And,  moreover,  while  bimetallism  is  entitled  to  be  judged 
like  any  other  political  institution,  with  reference  to  the  rea- 
sonable probabilities  of  the  future,  the  allowance  which  re- 
quires to  be  made  for  error  and  extraneous  force  is  less  than 
in  most  political  institutions,  inasmuch  as  the  failure  of 
bimetallism  involves  no  disaster  to  industry  or  society. 

When  an  engineer  designs  a  bridge  which  is  intended  to 
sustain  a  weight  of  eighty  tons,  he  introduces  a  "  factor  of 
safety,"  say  three  or  five,  and  makes  the  bridge  strong  enough 
to  bear  two  hundred  and  forty  or  four  hundred  tons.  The 


78  BIMETALLISM 

greater  the  calamity  which  would  result  from  the  breaking 
down  of  the  bridge  —  the  deeper  the  chasm  which  it  spans, 
the  swifter  the  torrent  below  —  the  larger  the  factor  of 
safety.  With  many  political  institutions,  likewise,  the  conse- 
quences of  failure  would  be  so  disastrous  that  the  statesman 
seeks  to  introduce  a  high  factor  of  safety;  but  in  the  case  of 
bimetallism  no  catastrophe  whatever  is  to  be  anticipated,  even 
in  the  event  of  failure.  At  the  worst,  after  the  drain  of  the 
dearer  metal,  in  consequence  of  changes  in  the  conditions  of 
supply,  is  completed,  the  bimetallic  country  is  simply  in  the 
same  position  with  the  countries  of  the  single  standard  using 
the  cheapened  metal.  While  the  process  of  substitution  is 
going  on,  it  sells  the  dearer  metal  at  a  premium;  when  the 
process  is  over,  it  is  no  worse  off  than  it  would  .have  been  had 
it  originally  selected  as  its  sole  money  of  full  legal-tender 
power  the  metal  which  it  has  bought  at  a  discount,  and  which 
other  countries,  perhaps  its  immediate  neighbours,  are  still 
using.  It  is  not  the  case  of  a  country  seeking  to  reject  the 
cheapening  metal,  and  to  supply  its  place  with  the  metal  which 
is  continually  becoming  scarcer  and  dearer.  .  .  .  There  is  all 
the  difference,  in  the  two  cases,  between  going  down  hill  and 
going  up  hill. 

Not  only  is  no  catastrophe  involved  in  the  failure  of  bi- 
metallism through  the  exhaustion  of  the  dearer  metal,  but  it 
is  always  in  the  power  of  the  Government  to  arrest  the  drain 
at  any  point  without  shock. 

Thus,  in  1874,  France  and  her  monetary  allies,  seeing  the 
prospect  of  a  considerable  drain  of  gold  through  the  importa- 
tion of  the  discarded  and  cheapened  silver  of  Germany,  and 
having  decided,  whether  wisely  or  unwisely,  not  to  prevent 
that  drain,  restricted  the  coinage  of  silver  without  repealing  or 
suspending  the  law  which  made  gold  and  silver  legal  tender 
indifferently  at  a  fixed  ratio.  Two  years  later,  finding  that 
the  forces  operating  to  lower  the  value  of  silver  were  powerful 
and  persistent,  the  coinage  of  silver  was  peremptorily  stopped. 

Can  one  point  to  any  sign  that  France  has  suffered  any 
special  injury  to  her  trade  and  production  from  this  act?  .  .  . 

We  now  have  to  note  .  .  .  that  every  additional  State 
which  joins  the  bimetallic  group,  having  the  same  mint  ratio 


IN  UNION  THERE  IS  STRENGTH  79 

between  gold  and  silver,  does  not  only  share  the  cost  or  the 
burden  with  those  already  in  the  system,  but  diminishes  the 
aggregate  cost  or  burden  to  be  borne,  and  this,  not  in  a  slight, 
but  in  an  important  degree,  so  that  should  the  monetary  league 
become  general,  the  total  cost  or  burden  to  be  divided  among 
the  many  allies  would  be  inappreciable;  while,  should  the 
system  come  to  embrace  all  commercial  States,  there  would, 
in  theory,  be  no  burden  at  all  to  be  borne  by  any  one. 

Thus  let  us  suppose  the  commercial  world  to  be  divided  into 
sixteen  States,  A  to  P,  inclusive,  the  first  six  having  the  single 
gold  standard,  four,  G  to  J,  the  so-called  double  standard  of 
gold  and  silver,  say  at  15^2  :  i;  the  remaining  six  States 
having  the  single  standard  of  silver,  thus : 

A,  B,  C,  D,  E,  F  (G,  H,  I,  J),  K,  L,  M,  N,  O,  P. 

It  is  evident  that  in  the  case  of  a  change  in  the  conditions 
of  supply  tending  to  cheapen  silver  relatively  to  gold,  the  new 
silver  would  pass  into  the  countries  of  the  double  standard,  G 
to  J,  be  there  exchanged  for  gold  at  the  rate  of  15^2  :  I, 
with  some  small  premium  as  the  profit  of  the  transaction,  and 
the  gold  would  go  to  the  gold  countries,  A  to  F,  in  settlement 
of  trade  balances. 

The  rapidity  with  which  this  substitution  of  silver  for  gold 
will  go  forward  will  depend,  first,  on  the  force  of  the  natural 
causes  operating  to  cheapen  silver,  and,  secondly,  on  the  force 
of  the  commercial  causes  operating  to  maintain  or  advance  the 
value  of  gold.  The  length  of  time  during  which  the  drain 
of  the  dearer  metal  can  be  sustained  without  exhaustion  will 
(given  the  rate  of  movement)  depend  solely  on  the  stock  of 
that  metal  existing  in  the  bimetallic  States  jointly  when  the 
drain  begins. 

But  chief  among  the  commercial  causes  operating  to  main- 
tain or  advance  the  value  of  gold  is  the  exclusive  power  with 
which  gold  is  invested  by  law  to  pay  debts  within  States  A  to 
F;  while  the  stock  of  the  dearer  metal  available  to  sustain  the 
drain  described  is  made  up,  not  of  all  the  gold  in  the  sixteen 
States  A  to  P,  or  in  the  ten  States  A  to  J,  but  only  of  the  gold 
in  the  four  bimetallic  States,  G  to  J. 

Hence  we  see  that  for  every  gold  State  which  adopts  the 
"  double  standard  "  the  amount  of  gold  available,  in  the  case 


8o  BIMETALLISM 

of  a  cheapening  of  silver,  to  meet  the  drain  of  the  dearer 
metal  (on  which  the  virtue  of  the  bimetallic  system  depends) 
is  increased;  while  the  demand  for  gold  in  preference  to  silver 
at  15^/2  :  i  (the  only  cause  which  threatens  the  stability  of 
the  bimetallic  system)  is,  in  just  so  far,  diminished.  On  the 
other  hand,  every  silver  State  that  adopts  the  "  double  stand- 
ard "  strengthens  the  bimetallic  system  in  the  case  of  a  cheap- 
ening of  gold. 

Let  us  suppose  the  sixteen  commercial  States  to  be  divided 
as  four  gold  States,  eight  gold  and  silver  States,  and  four 
silver  States,  as  follows: 

A,  B,  C,  D  (E,  F,  G,  H,  I,  J,  K,  L),  M,  N,  O,  F. 

We  see  that  the  bimetallic  system  is  now  not  twice  as  strong 
merely  as  in  the  case  first  assumed,  but  many  times  as  strong, 
since  not  only  is  the  amount  of  the  dearer  metal  (whichever 
that  may  at  the  time  be)  subject  to  drain  greatly  increased, 
but  the  demand  for  that  metal,  in  preference  to  silver  at 
1 5^  :  I,  now  comes  from  four  countries  only,  instead  of  six, 
as  formerly.  The  transfer  of  still  another  State  from  each 
of  the  two  single-standard  groups  would  vastly  increase  the 
stability  of  the  bimetallic  system,  A,  B,  C  (D,  E,  F,  G,  H,  I, 
J,  K,  L,  M),  N,  O,  P.  Not  only  would  the" base  of  the  system 
be  broadened  by  bringing  the  dearer  metal  of  ten  States,  D  to 
M,  under  tribute  in  the  event  of  changes  operating  on  the 
supply  of  either  to  affect  its  value;  but  the  force  of  the  causes 
threatening  the  equilibrium  of  the  system  would  be  reduced, 
since  the  demand  for  the  dearer  metal  would  now  come  from 
only  three  States:  A,  B,  C,  in  the  case  of  a  cheapening  of 
silver  relatively  to  gold;  N,  O,  P,  in  the  case  of  a  cheapening 
of  gold  relatively  to  silver. 

Bring  still  another  State  from  each  group  into  the  monetary 
union,  and  the  danger  of  a  breaking  down  of  the  system,  under 
any  change  in  the  conditions  of  supply  which  it  would  be 
reasonable  to  anticipate,  almost  disappears. 

A,  B  (C,  D,  E,  F,  G,  H,  I,  J,  K,  L,  M,  N),  O,  P.  Twelve 
States  now  supply  the  dearer  metal ;  only  two  States  will  take 
it  in  preference  to  the  other  at  the  ratio  of  the  mint.  Those 
two  States  —  whether  A,  B,  or  O,  P  —  can  not  take  the 
dearer  metal  indefinitely.  They  will  soon  be  surfeited.  A 


NO  MACHINERY  INVOLVED  8l 

further  increase  of  money  in  them  would  only  be  followed  by 
a  fall  in  its  value,  which  would  soon  proceed  so  far  as  to  bring 
the  metals  together  again.  What  the  one  metal  would  tend 
to  lose  in  value  through  increase  of  supply,  the  other  would 
tend  to  lose  through  diminution  of  demand. 

This  is  the  Modern  Bimetallic  Scheme  advocated  by  Wolow- 
ski  and  Cernuschi  in  France,  Malou  and  de  Laveleye  in 
Belgium,  Mees  and  Vrolik  in  Holland,  Schneider  in  Germany, 
Haupt  in  Austria,  Seyd  and  the  Liverpool  writers  in  England, 
Horton,  Nourse,  and  George  Walker  in  the  United  States. 

It  differs  widely  from  the  plan  of  the  so-called  "  double 
standard/'  which  was  pronounced  impracticable  by  Locke, 
Adam  Smith,  and  Ricardo.  Not  the  smallest  presumption 
against  the  reasonableness  of  this  scheme  is  created  by  the 
fact  that  eminent  economists  of  the  past  century,  and  of  the 
first  half  of  the  present,  declared  in  favour  of  the  single  stand- 
ard, whether  of  gold  or  of  silver.  Those  writers  contemplated 
a  condition  of  international  relations  in  which  anything  like 
general  and  permanent  concert  of  action,  in  establishing  and 
maintaining  a  ratio  between  the  metals  in  the  coinage,  would 
have  been  wholly  beyond  reasonable  expectation.  .  .  . 

A  general  or  universal  system  of  bimetallism  would  involve 
no  machinery,  no  international  accounts,  no  detail  whatever. 
The  simple  agreement  of  governments  to  coin  at  a  certain 
ratio  would  be  sufficient  for  all  the  objects  that  have  been 
discussed.  If  unification  of  coinage,  identity  of  money- 
pieces,  and  mutual  acceptance  of  coins  by  the  several  nations 
forming  such  a  monetary  league,  were  to  be  added,  some 
machinery  for  the  redemption  of  worn  pieces  might  require 
to  be  brought  into  existence;  but  this  is  not  a  necessary  fea- 
ture of  successful  bimetallism,  which  would  be  entirely  com- 
patible with  the  retention  by  each  State  of  its  own  devices 
and  denominations,  and  with  the  exchange  of  moneys  as  at 
present  effected.  .  .  . 


CHAPTER  VII 
THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

1  SUCH  was  the  singular  combination  of  events  after  the 
peace  of  1865  that  almost  at  the  moment  when  a  million 
citizens  were  turned  from  organised  destruction  to  pursuit  of 
peaceful  industry,  the  avenues  of  American  employment  and 
production  were  widened  in  a  degree  unprecedented  in  the 
history  of  trade.  Within  eight  years  after  Lee's  surrender, 
the  railway  mileage  of  the  United  States  was  literally  doubled. 
Only  a  fraction  of  this  increase  belonged  to  the  trans- 
continental lines  which  linked  the  two  oceans  in  1869.  Quite 
aside  from  the  1,800  miles  of  the  Pacific  railways,  upwards 
of  30,000  miles  of  track  were  laid  in  the  United  States  be- 
tween 1865  and  1873.  Four  noteworthy  economic  develop- 
ments accompanied  this  extension  of  the  transportation  system. 
A  fertile  interior  domain,  hitherto  untouched,  was  opened  up 
to  industry.  With  the  rush  of  population  to  these  Western 
districts,  not  only  did  the  disbanded  army  resume  production 
without  industrial  overcrowding  such  as  followed  the  Napole- 
onic wars,  but  provision  was  made  for  three  or  four  hundred 
thousand  immigrants  annually.  European  capital  in  enormous 
volume  was  drawn  upon  to  provide  the  means  for  this  develop- 
ment. Finally,  the  United  States  rose  from  the  position  of  a 
second-  or  third-class  commercial  State  to  the  first  rank  among 
agricultural  producers  and  exporters.  Each  of  these  several 
phenomena  had  its  special  influence  on  the  period. 

Not  less  immediately  connected  with  this  opening  up  and 
settlement  of  our  agricultural  West  was  still  another  phe- 
nomenon, of  peculiar  interest  to  the  study  of  the  ensuing 
period.  The  average  price  of  grain  had  advanced  with  great 
rapidity  during  the  Civil  War.  In  1867,  the  price  of  wheat, 

1  Adapted  from  A.  D.  Noyes,  Forty  Years  of  American  Finance,  pp. 
2-6.    G.  P.  Putnam's  Sons,  New  York  and  London.     1909. 

82 


ORIGIN  OF  SILVER  MOVEMENT  83 

even  on  the  Chicago  market,  reached  the  remarkable  level  of 
$2.85  per  bushel;  nor  was  this  price  very  greatly  above  the 
annual  maximum  of  the  period.  In  a  large  degree,  this  ad- 
vance resulted  from  inflation  of  the  American  currency.  But 
the  upward  movement  was  world-wide;  in  1867  and  1868  the 
average  price,  even  in  England,  was  close  to  the  equivalent  of 
two  dollars  a  bushel.  That  any  such  abnormal  market  could 
be  maintained  in  the  face  of  the  new  American  supplies  was 
at  least  improbable.  The  increase  in  cereal  production  was 
twice  as  rapid  as  the  country's  increase  in  population;  the 
United  States  became  therefore  the  leading  figure  in  the 
world's  export  markets ;  and  this  was  certain  to  have  important 
influence  on  prices. 

As  in  America,  so  in  Europe,  production  received  immediate 
stimulus.  While  American  capital  was  opening  up  the  Missis- 
sippi Valley,  European  capital  was  similarly  busy  along  the 
fertile  river  basins  of  the  Dnieper  and  the  Danube.  The 
Russian  railway  system  grew  during  this  period  from  some- 
thing like  2,000  miles  to  upwards  of  13,000.  In  Austria-Hun- 
gary the  percentage  of  increase  was  almost  equally  large.  All 
of  these  new  transportation  lines,  like  our  own  new  Granger 
railways,  were  at  once  engaged  in  carrying  to  the  seaboard 
supplies  of  grain  which  never  before  had  reached  an  export 
market.  The  problem  of  an  earlier  generation  had  been  how 
to  feed  the  constantly  increasing  population;  a  wholly  new 
problem  was  presently  to  arise,  based  on  the  question  how  to 
find  a  ready  and  profitable  market  for  the  year's  output  of 
breadstuffs.  Prices,  in  short,  which  rose  almost  continuously 
throughout  the  world  during  the  period  of  slack  production 
from  1858  to  1873,  receded  almost  as  continuously  in  the  en- 
suing generation.  Nowhere  was  this  phenomenon  destined 
to  have  more  immediate  importance,  economically,  socially, 
and  politically,  than  in  the  United  States. 

The  opinion  is  more  or  less  widely  held  that  the  decline  in 
prices,  notably  of  grain,  has  resulted  from  legislation  on  the 
currency.  Without  for  the  present  arguing  that  proposition,  it 
may  be  affirmed  with  entire  safety  that  a  good  share  of  the 
period's  currency  legislation  has  resulted  from  the  decline  in 
the  price  of  grain.  The  fall  in  wheat  has  been  the  typical 


84       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

argument  for  arbitrary  increase  of  the  silver  or  paper  currency 
.in  almost  every  Congressional  debate  since  1872.  What  is 
.perhaps  even  more  significant,  the  division  in  almost  every 
Congressional  vote  upon  these  subjects  has  been,  not  political 
but  geographical  —  the  commercial  East  against  the  agricul- 
tural West. 


AGITATION  FOR  SILVER  AND  THE  PASSAGE  OF  THE.  BLAND 

BILL 

1  In  the  summer  session  of  1876,  several  bills  had  been  in- 
troduced, providing  for  increased  silver  coinage  and  for  re- 
monetization  of  the  silver  dollar.  None  of  these  propositions 
came  to  anything;  they  were  chiefly  remarkable  from  the  fact 
that  they  first  gave  vogue  to  the  theory  of  the  ""crime  of  1873  " 
• — a  theory  which  assumed  that  the  dropping  of  the  silver 
dollar  from  the  list  of  coins  in  the  statutes  of  that  year  was 
the  outcome  of  a  conspiracy  which  carried  its  legislation 
through  in  secret.  The  entire  baselessness  of  this  assertion 
has  been  demonstrated  often  enough  and  in  convincing  detail ; 
this  very  provision  regarding  the  silver  dollar  was  a  subject 
of  public  discussion  in  the  House,  and  met  with  no  serious 
opposition.  The  assertion  in  itself  is  so  patently  absurd  that 
I  shall  not  pause  to  discuss  it.  The  truth  is  that  silver  in 
1873,  and  during  a  generation  before  that  date,  was  worth 
more  to  its  owner  in  the  form  of  bullion  than  in  the  form  of 
coin.  In  1872  the  silver  requisite  to  coin  a  dollar  at  the 
established  ratio  was  worth  $1.02.  For  years,  therefore,  no- 
body thought  of  bringing  his  silver  to  the  mint  for  coinage ;  he 
sold  it  in  the  commercial  markets.  The  total  silver-dollar 
coinage  of  the  United  States,  between  1789  and  1873,  was 
barely  eight  million  dollars,  and  when,  in  1873,  the  law  pro- 
vided that  except  for  the  so-called  trade  dollar  coined  for  ex- 
port, "  no  deposit  of  silver  for  other  coinage  shall  be  received," 
no  one  had  interest  enough  in  the  matter  to  offer  criticism. 

But  in  1874  and  1875  came  one  of  those  curious  coin- 
cidences which  render  possible  for  all  time  conflicting  theories 
of  an  economic  event.  Germany,  having  adopted  the  gold 

.,  pp.  35-44- 


NATURE  OF  SILVER  MOVEMENT  85 

standard  of  currency  in  July,  1873,  began  to  sell  its  old  silver 
coin  as  bullion.  At  exactly  the  same  time,  Mackay  and  Fair, 
in  the  heart  of  the  Nevada  Mountains,  were  opening  up  the 
Great  Bonanza.  The  Pacific  Coast  was  in  fact  going  wild 
over  the  rise  in  mining  shares  while  the  East  was  financially 
and  industrially  paralysed. 

The  statute  dropping  the  silver  dollar  from  this  country's 
coinage  list  was  enacted  February  12,  1873;  the  German  law 
for  retirement  of  silver  coinage  was  adopted  July  9,  1873; 
and  a  year  later  the  news  of  the  rich  Nevada  "  ore-finds  "  be- 
came public  property.  Between  the  German  sales  and  the 
sales  at  Nevada  City,  the  price  of  silver  yielded.  In  1874,  for 
the  first  time  in  a  generation,  412^2  grains  of  standard  silver 
would  have  been  worth  more  when  coined  into  a  legal-tender 
dollar  than  when  sold  in  the  bullion  market.  The  motive  of 
the  mining  interest  in  the  free-silver  coinage  agitation  of  1876 
and  1877  was  not  mysterious. 

The  motive  of  the  anti- Administration  party  in  Congress 
was  somewhat  different.  There  is  not  the  slightest  question 
that  the  silver-coinage  movement,  in  the  agricultural  West 
particularly,  had  the  same  origin  and  the  same  following  as 
the  paper  inflation  movement  of  a  few  years  before.  Mr. 
Bland  himself,  the  author  of  the  silver  bill,  declared  that  the 
question  was  presented  as  between  what  he  called  "  honest 
resumption "  with  silver  coinage,  "  or  on  the  other  hand  a 
forced  unlimited  inflation  of  paper  money."  In  the  heat  of 
debate  on  the  silver  bill,  the  same  statesman  declared  in  Con- 
gress that  if  his  coinage  plan  could  not  be  passed,  he  was  "  in 
favour  of  issuing  paper  money  enough  to  stuff  down  the  bond- 
holders until  they  are  sick."  The  point  of  these  remarks  lies 
in  their  frank  assumption  that  the  free-silver  sentiment  and 
the  fiat-money  sentiment  were  interchangeable. 

So  much,  then,  for  the  origin  and  nature  of  the  silver  move- 
ment. The  Bland  Bill  passed  the  House  on  November  5, 
1877,  under  the  previous  question  and  without  debate,  by  a 
vote  of  164  to  34,  and  the  resumption  operations  of  the  Gov- 
ernment came  to  an  instant  halt.  The  market  price  of  silver 
then  was  such  that  the  legal-tender  dollar  of  the  Act  would 
have  been  worth  intrinsically  less  than  ninety  cents.  Foreign 


86       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

subscribers  to  our  resumption  bonds  suspected  instantly  that 
payment  of  the  Government  debt  in  a  depreciated  coin  was 
planned  by  Congress;  their  suspicions  were  confirmed  by  a 
resolution  introduced  December  6th  by  Stanley  Matthews,  Mr. 
Sherman's  own  successor  in  the  Senate,  and  passed  by  both 
houses.  The  resolution  explicitly  declared  that  in  the  opinion 
of  Congress,  all  the  bonds  of  the  United  States,  "  issued  or 
authorized  to  be  issued,"  were  payable  in  the  silver  dollars  of 
the  Bland  Law.  The  extraordinary  character  of  this  resolu- 
tion may  be  judged  from  the  fact  that  it  was  proposed  and 
passed  in  both  houses  while  the  Coinage  Act  was  still  pend- 
ing, and  while,  therefore,  there  was  not  in  existence  the  coin 
which  was  duly  declared  a  legal  tender  for  settlement  with 
public  creditors.  To  the  conservative  portion  of  the  public, 
the  resolution  seemed  a  piece  of  financial  lunacy;  to  the  Treas- 
ury, it  was  not  only  embarrassing  but  humiliating.  Hardly  a 
month  before,  in  his  annual  report  to  Congress,  the  Secretary 
had  repeated  his  official  statement,  previously  made  to  bond 
subscribers,  that  payment  of  the  bonds  in  gold  might  safely 
be  anticipated.  The  publication  of  this  statement  in  New  York 
and  London  had  been  followed  by  greatly  increased  sub- 
scriptions to  the  bonds,  in  payment  of  which  gold  was  required 
by  the  Government.  The  Matthews  resolution  amounted,  so 
far  as  Congress  was  concerned,  to  repudiation  of  a  formal  bar- 
gain of  which  the  Government  had  already  obtained  the  fruits. 
The  debate  was  such  as  might  have  been  expected  on  a  measure 
of  the  sort.  It  centred  repeatedly  on  denunciation  of  Govern- 
ment bond  investors.  Foreign  subscribers  were  treated  with 
especial  scorn ;  indeed,  our  foreign  customers  in  general  were 
not  spared.  It  was  this  debate  which  drew  forth  Senator 
Matthews's  somewhat  celebrated  query :  "  What  have  we 
got  to  do  with  abroad?" — a  remark  which  was  perhaps  as 
typical  of  the  session's  deliberations  as  any  utterance  made 
from  the  floor  of  Congress. 

The  situation,  during  the  early  months  of  1878,  was  ex- 
tremely critical.  For  the  time  the  three  direct  assaults  on  the 
public  credit  were  warded  off.  The  Matthews  resolution  was 
"  concurrent,"  and  hence  a  mere  expression  of  opinion  without 
binding  force.  The  bill  repealing  the  Resumption  Act  of  1875 


PROVISIONS  OF  THE  ACT  OF  1878  *7 

was  killed  by  disagreement  in  the  Senate.  Meantime  the 
Silver-Coinage  Act  was  modified  by  the  Senate  into  a  compro- 
mise requiring  purchase  and  coinage  by  the  Government  of  two 
to  four  millions'  worth  of  silver  monthly.  Even  thus  modified, 
it  encountered  the  veto  of  the  President,  but  was  passed  over 
his  veto,  without  a  day's  delay,  by  the  requisite  two-thirds  ma- 
jority. Executive  conservatism  seemed  to  be  fruitless ;  never- 
theless, there  is  no  doubt  whatever  that  the  steadfast  policy  of 
Mr.  Hayes  did  much  to  stem  the  current  of  reaction. 

Congress  adjourned  on  June  I9th.  Even  before  Congres- 
sional adjournment,  the  canvass  for  the  November  State  elec- 
tions had  begun.  The  State  Convention  platforms  in  the  sum-) 
mer  of  1878,  were  not  in  all  respects  such  as  the  session's  work 
in  Congress  would  have  suggested. 

The  opposition  had  gone  too  far  in  Congress,  and  popular 
opinion  to  that  effect  was  expressed  with  sufficient  emphasis 
in  November,  1878.  The  Administration  party  gained  what 
amounted  to  a  decided  victory.  There  were  but  four  States, 
East  or  West,  where  opposition  majorities  were  increased  in 
1878  or  Administration  majorities  diminished,  and  these  were 
agricultural  States,  where  the  season's  sharp  decline  in  wheat 
had  stirred  up  discontent.  There  was  not  much  danger  from 
the  closing  session  of  a  Congress  whose  earlier  ventures  had 
received  this  response  from  the  people. 

PROVISIONS  OF  THE  ACT  OF  1878 

1  Although  the  silver  dollar  of  which  the  coinage  was  re- 
sumed in  1878,  dates  back  as  a  coin  to  the  earlier  days  of  the 
Republic,  its  reissue  in  that  year  marks  a  policy  so  radically  new 
that  the  experience  of  previous  years  throws  practically  no  light 
on  its  working.  The  act  of  1878  provided  for  the  purchase 
by  the  Government,  each  month,  of  not  less  than  two  million 
dollars'  worth,  and  not  more  than  four  million  dollars'  worth 
of  silver  bullion,  for  coinage  into  silver  dollars  at  the  rate  of 
4i2l/2  grains  of  standard  silver  (or  371^4  grains  of  fine  sil- 
ver) for  each  dollar.  The  amount  of  the  purchases,  within 
the  specified  limits,  was  left  to  the  discretion  of  the  Secretary 

1 F.  W.  Taussig,  The  Silver  Situation  in  the  United  States,  pp.  8,  9. 
G.  P.  Putnam's  Sons.     New  York.     1893. 


88       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

of  the  Treasury.  As  every  Secretary  of  the  Treasury, 
throughout  the  period  in  which  the  act  was  in  force,  kept  to 
the  minimum  amount,  the  practical  result  was  a  monthly  pur- 
chase of  two  million  dollars'  worth  of  silver  bullion. 

The  act  is  sometimes  described  as  having  called  for  a 
monthly  issue  of  two  million  silver  dollars;  but  this  was  not 
the  exact  situation.  The  amount  of  silver  obtainable  with 
two  million  dollars  obviously  varies  according  to  the  price  of 
the  metal  in  terms  of  the  dollars  with  which  the  purchases  are 
made.  In  February,  1878,  when  the  first  purchases  were  made, 
those  dollars  were  the  inconvertible  United  States  notes,  or 
greenbacks,  worth  something  less  than  their  face  in  gold. 
The  amount  of  silver  bullion  obtainable  with  two  million  such 
dollars  depended,  on  the  one  hand,  on  the  price  of  silver  bul- 
lion in  terms  of  gold,  and  on  the  other  hand  on  the  value  of  the 
dollars  themselves  in  terms  of  gold.  When  specie  payments 
were  resumed,  on  the  first  of  January,  1879,  and  the  greenbacks 
became  redeemable  in  gold,  the  measure  of  value  in  the  United 
States  became  gold,  and  the  extent  of  the  coinage  of  silver 
dollars  under  the  act  of  1878  became  simply  a  question  of  how 
much  silver  bullion  could  be  bought  with  two  million  dollars 
of  gold.  The  price  of  silver  in  1878  was,  in  terms  of  gold, 
not  far  from  a  dollar  for  an  ounce  of  standard  silver.  Since 
1878  it  has  gone  down  almost  steadily,  and  ...  in  1889  was 
barely  above  80  cents  an  ounce.1  The  silver  dollar  of  412^2 
grains  contains  less  than  an  ounce  (480  grains)  of  standard 
silver.  The  monthly  purchase  of  two  million  dollars'  worth 
of  silver  has  therefore  always  yielded  more  than  two  million 
silver  dollars,  the  amount  being  obviously  greater  as  the  price 
of  silver  went  lower.  On  the  average,  the  monthly  yield  [was] 
not  far  from  two  million  and  a  half  of  silver  dollars.  .  .  . 
Thirty  millions  of  silver  dollars  a  year  was  roughly  the  addi- 
tion to  the  currency  of  the  community  from  the  act  of  1878. 

1 1  have  stated  the  price  here,  for  simplicity,  in  terms  of  so  much  per 
ounce  of  standard  silver,  i,  e.,  silver  containing  10  per  cent,  of  alloy. 
The  usual  quotation  in  the  United  States  is  per  ounce  of  fine  silver. 
[Thus,  the  New  York  price,  March  10,  1916,  was  56^  cents  per  ounce  of 
fine  silver.] 


PROVISIONS  OF  THE  ACT  OF  1878  °9 

SILVER   CERTIFICATES 

1  An  important  provision  of  the  act  of  1878  was  that  au- 
thorising the  issue  of  silver  certificates  against  the  deposit  of 
silver  dollars.     This  authority  was  limited  at  the  time  to  cer- 
tificates in  denominations  only  of  ten  dollars  and  upward:  a 
restriction  which  .  .  .  proved  to  be  of  great  importance.     At 
the  time  it  does  not  seem  to  have  been  expected  that  the  silver 
certificates  would  enter  directly  into  the  circulating  medium; 
we  may  infer  from  the  restriction  to  large  denominations  that 
no  such  expectation  was  entertained.     But  in  fact,  it  has  been 
chiefly  in  the  form  of  certificates  that  the  silver  has  entered 
into  circulation.     These  certificates,  it  is  true,  are  not,  like  the 
dollars  themselves,  a  legal  tender;  but  they  are  receivable  for 
all  public  dues,  customs  included,  and  they  pass  from  hand  to 
hand  at  least  as  readily  as  the  bulky  pieces  which  they  rep- 
resent. 

CAUSES  OF  THE  ACT 

2  The  passage  of  that  act  was  due  to  causes  easily  described. 
It  was  part  of  the  opposition  to  the  contraction  of  the  currency 
and  the  resumption  of  specie  payments  wrhich  forms  the  most 
important  episode  in  our  financial  history  between  1867  and 
1879.     The  resumption  of  specie  payments  had  been  provided 
for  by  the  act  of  1875,  and  was  to  take  place  on  January  i, 
1879.     In  the  meanwhile,  the  long-continued  depression  which 
followed  the  crisis  of  1873  intensified  the  demand  for  more 
money  and  higher  prices.     That  demand  led  to  the  inflation  bill 
passed  by  both  Houses  of  Congress  in  1878,  and  killed  by  the 
veto  of  President  Grant.     The  same  feeling  led  to  the  silver 
act.     The  great  fall  in  the  price  of  silver,  beginning  in  1873, 
and  showing  itself  markedly  in  1876,  made  silver,  at  the  old 
ratio,  a  cheaper  currency  than  gold,  and  so  caused  the  oppon- 
ents of  the  return  to  specie  payments  to  prefer  silver  to  gold, 
as  they  preferred  paper  to  either.     No  doubt  some  additional 
force  was  given  to  the  movement  in  favor  of  the  use  of  silver 
from  the  desire  of  the  silver-mining  States  and  their  repre- 

pp.  9,  IQ,  ? /&«*•»  pp.  IQ,  ii. 


90        THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

sentatives,  that  the  price  of  the  metal  should  be  kept  up  through 
a  larger  use  of  it  for  coinage.  .  .  . 


WHEREIN  PECULIAR 

1  Although  the  specific  measure  passed  in  1878  thus  rested 
on  a  long  train  of  historical  causes,  it  contained  details  that 
were  essentially  new,  not  only  in  our  own  experience,  but  in 
that  of  the  world  at  large.  ...  It  ...  provided  for  a  regular 
mechanical  addition  of  large  amount  to  the  general  circulating 
medium.  No  precise  experiment  of  this  kind  had  ever  been 
tried.  It  is  true  that  Germany  and  the  countries  of  the  Latin 
Union  possess,  in  their  circulating  medium,  large  quantities 
of  over-valued  thalers  and  five-franc  pieces  which  are  exactly 
like  our  silver  dollars.  They  also  are  legal  -tender  without 
limit;  their  total  quantity  is  limited;  and  it  is  only  by  this 
limitation  of  the  quantity  that  their  value  is  kept  above  that 
of  the  bullion  contained  in  them.  But  the  thalers  and  francs 
in  these  countries  are  not  new  additions  to  the  currency. 
They  are  remnants  from  an  earlier  period,  when  Germany  had 
a  silver  standard,  and  the  Latin  Union  a  complete  bimetallic 
standard.  No  addition  whatever  to  the  thalers  is  made  in 
Germany;  and  if  some  coinage  of  five- franc  pieces  takes  place 
in  France  and  in  other  countries  of  the  Latin  Union,  the  addi- 
tions are  meant  merely  to  fill  the  place  of  abraded  coins,  to 
provide  for  the  ordinary  losses  from  daily  use,  and  to  make 
any  additions  to  the  supply  which  may  be  needed  for  conven- 
ience in  making  small  change.  No  other  country  has  ever 
entered  on  an  addition  of  over-valued  coin  to  its  circulating 
medium  having  the  object  and  extent  of  that  made  by  our 
silver  act  of  1878.  This  characteristic  of  the  measure,  it  need 
hardly  be  said,  was  the  result  not  of  any  deliberate  intention 
to  try  a  new  experiment,  but  of  the  spirit  of  compromise  which 
explains  so  many  anomalies  in  the  legislation  of  democratic 
communities.  The  silver  act,  as  passed  by  the  House  of  Rep- 
resentatives, provided  for  complete  bimetallism  —  for  the  free 
and  unlimited  coinage  of  the  silver  dollar  at  the  old  ratio  of 
1 6  to  i.  In  the  Senate,  it  was  amended  by  the  substitution  of 

1  Ibid.,  pp.  11-13. 


CIRCULATION  OF  SILVER  DOLLARS  91 

the  provisions  for  a  limited  coinage,  which  were  finally  en- 
acted. The  compromise  was  meant  to  satisfy  both  those  who 
objected  to  the  cheaper  standard  and  those  who  wanted  more 
money;  and  it  afforded  a  welcome  escape  to  the  legislators 
who  were  trying  to  satisfy  all  parties.  At  the  time,  no  one 
probably  expected  that  the  measure  would  remain  in  force  for 
any  great  length  of  time.  The  conservative  element  hoped 
that  it  would  be  repealed  after  a  short  trial;  the  inflationists 
(for  by  that  name  they  might,  then  at  least,  fairly  be  called) 
believed  that  it  would  soon  be  superseded  by  the  free  and  un- 
limited coinage  of  silver.  As  it  happened,  the  act  remained  in 
force,  unamended,  and  indeed  without  very  serious  attempt  at 
amendment,  for  over  twelve  years ;  and  the  measure  which  suc- 
ceeded it  in  1890,  though  different  in  many  details,  followed 
the  same  method  of  forcing  a  large  regular  injection  into  the 
circulating  medium  of  money  based  on  silver  purchases  by  the 
Government. 

LIMITED  CIRCULATION  OF  THE  SILVER  DOLLARS 

1  The  Government  has  made  every  effort  to  get  the  dollar 
coins  out  of  its  hands.  .  .  .  But  the  great  bulk  of  the  coins 
thus  got  out  of  the  treasury  return  to  it  almost  at  once.     The 
degree  of  favor  which  they  meet  with  of  course  .  .  .  varies  in 
different  parts  of  the  country,  apparently  reflecting  in  a  curious 
way  the  popular  feeling  as  to  the  desirability  of  having  silver 
currency  at  all.     They  circulate  very  little  east  of  the  Alle- 
ghanies,  but  are  used  more   freely  and  permanently  in  the 
Mississippi  Valley.     Among  the  negroes  of  the  South  the  big 
pieces  are  said  to  be  favorites,  and  to  find  a  permanent  lodg- 
ment.    Their  greatest  circulation  .  .  .  was  reachedi  n  1886; 
after  that  time  the  change  in  the  denominations  of  silver  cer- 
tificates caused  a  decline  in  the  amount  used. 

PROVISIONS  OF  THE  ACT  OF  1890 

2  The  act  of  July  14,  1890,  is3  more  remarkable  than  that 
of  1878.     It  is  unique  in  monetary  history.     It  provides  that 

1  Ibid.,  pp.  19,  20. 
2 1  bid.,  pp.  50,  51. 

3  [Present  tense  because  written  while  the  act  was  still  in  force.] 


92       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

the  Secretary  of  the  Treasury  shall  purchase  each  month  at 
the  market  price  four  and  a  half  million  ounces  of  silver 
bullion.  In  payment  he  shall  issue  Treasury  notes  of  the 
United  States,  in  denominations  of  between  one  dollar  and 
one  thousand  dollars.  These  Treasury  notes,  unlike  the  old 
silver  certificates,  are  a  direct  legal  tender  for  all  debts,  public 
or  private,  unless  a  different  medium  is  expressly  stipulated  in 
the  contract.  They  differ  from  the  silver  certificates  in 
another  respect;  they  are  redeemable  either  in  gold  or  silver 
coin,  at  the  discretion  of  the  Secretary  of  the  Treasury.  The 
indirect  process  of  redemption  which,  .  .  .  was  applied  to 
the  silver  certificates,  is  replaced  for  the  new  notes  by  direct 
redemption.  The  avowed  object  is  to  keep  the  silver  money 
equal  to  gold,  for  it  is  declared  to  be  "  the  established  policy 
of  the  United  States  to  maintain  the  two  metals  at  a  parity 
with  each  other  on  the  present  legal  ratio,  or  such  ratio  as 
may  be  provided  by  law."  The  act  of  1878  is  repealed; 
but  the  coinage  of  two  million  ounces  of  silver  into  dollars  is 
to  be  continued  for  a  year  (until  July  i,  1891).  Thereafter 
it  is  directed  that  only  so  many  silver  dollars  shall  be  coined 
as  may  be  needed  for  redeeming  any  Treasury  notes  presented 
for  redemption.  Practically  this  means  that  the  coinage  shall 
cease ;  redemption  in  silver  dollars  will  not  be  called  for  under 
present  conditions.  The  coinage  of  silver  dollars  accordingly 
was  suspended  by  the  Treasury  on  July  i,  1891;  a  change 
which  was  the  occasion  of  some  vociferous  abuse  and  equally 
vociferous  praise,  but  which  in  reality  was  of  no  consequence 
whatever. 

AMOUNT  OF   MONTHLY  ISSUES 

1  The  monthly  issues  of  the  new  Treasury  notes  vary,  like 
those  of  the  old  silver  certificates,  with  the  price  of  silver. 
But  the  new  issues  vary  directly  with  the  price  of  silver,  while 
as  we  have  seen,  the  old  issues  varied  inversely  with  the  price. 
The  volume  of  Treasury  notes  issued  is  equal  to  the  market 
price  of  four  and  one-half  million  ounces  of  silver.  For  a 
month  or  two  after  the  passage  of  the  act,  the  price  of  silver 
advanced  rapidly,  and  at  its  highest,  on  August  19,  1890, 

llbid.,  pp.  51,  52 


THE  ARGUMENT  FOR  SILVER  93 

touched     $1.20.     After     September    a    steady    decline     set 
in.  .  .  . 

THE  POLICY  OF  THE  BANKS 

1  Shortly  after  the  passage  of  the  act  [of  1890],  some  sort 
of  understanding  seems  to  have  been  reached  between  the 
Treasury  Department  and  the  banks   of   New   York.     The 
banks  came  to  an  agreement  that  the  new  notes  were  to  be 
treated  as  "  current  funds,"  receivable  in  all  payments,  clear- 
ing-house settlements  included.  .  .  . 

The  fact  that  the  new  notes  were  received  by  the  banks 
from  the  Sub-Treasury  in  settlement  of  clearings,  was  of 
sensible  advantage  to  the  Government.  The  success  of  the 
Government  in  maintaining  its  nominal  willingness  to  pay 
gold  to  all  comers  was  due  to  the  forbearance  of  the  banks. 
Gold  was  called  for  by  them  only  when  needed  for  export. 

THE  ARGUMENT  FOR  SILVER 
THE  BIMETALLIST  ARGUMENTS 

2  ...  Is  it  desirable  that  we  should  have  more  money  ? 
Does  the  maintenance  of  the  gold  standard  involve  injustice 
or  hardship  to  debtors,  or  to  any  class  in  the  community? 
Does  it  have  any  ill  effects  in  hampering  industry  or  checking 
the  advance  of  production?     Is  the  free  coinage  of  silver,  or 
any  measure  leading  ultimately  to  a  silver  basis,  fairly  open 
to  the  objections  commonly  urged  against  it  on  the  grounds 
of  dishonesty  and  injustice?  .  .  . 

In  considering  these  questions,  we  must  look  to  the  ultimate 
and  permanent  results  of  the  silver  standard.  The  details 
...  as  to  the  mode  in  which  the  silver  issues  circulate  and 
the  degree  of  promptness  with  which  they  will  affect  prices, 
are  here  of  no  great  importance.  Under  a  silver  standard 
the  rise  in  prices  will  take  place  in  the  end ;  and  we  are  con- 
cerned with  the  social  consequences  of  such  an  eventual  re- 
sult. .  .  . 

I  propose  here  to  take  up  chiefly  one  set  of  serious  argu- 

1  Ibid.,  pp.  52,  59.  2  Ibid.,  pp.  84-106. 


94       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

ments  —  those  which  rest  on  the  changes  in  general  prices 
which  have  taken  place  throughout  the  civilised  world  in  the 
last  twenty  years.  The  conclusions  in  favor  of  a  wider  use 
of  silver,  drawn  from  such  changes,  have  been  maintained  by 
distinguished  economists.  It  is  true  that  the  particular  plans 
for  the  use  of  silver  which  are  now  in  vogue  in  the  United 
States  have  generally  been  opposed  by  these  economists.  They 
have  urged  international  agreements  for  the  wider  use  of 
silver,  and  have  deprecated  independent  action  by  any  one 
nation.  But  the  more  thorough-going  advocates  of  free  silver 
in  the  United  States  say,  certainly  with  much  force,  that  an 
international  agreement  has  proved  to  be  simply  impracticable, 
and  that  if  the  wider  use  of  silver  is  to  be  deferred  until  there 
is  concerted  action  by  the  great  nations,  it  will  never  come.  If 
anything  in  this  direction  is  to  be  done,  some  one  country 
must  be  courageous  enough  to  take  the  lead,  trusting  that  . 
others  will  follow  in  due  time.  And  certainly  it  is  true  that 
the  scheme  for  international  bimetallism  has  practically  no 
prospect  of  adoption;  while,  on  the  other  hand,  the  serious 
arguments  urged  by  its  advocates  tell,  in  some  degree,  in  favor 
of  any  scheme  for  enlarging  the  use  of  silver  as  money.  These 
arguments,  moreover,  are  of  weight,  and  deserve  a  more 
painstaking  consideration  than  is  often  admitted  by  those  who 
oppose  the  silver  legislation  of  the  United  States. 

The  serious  and  important  arguments,  then,  among  those 
who,  both  in  this  country  and  in  Europe,  advocate  a  greater 
use  of  silver  as  money,  are  derived  from  the  general  fall  in 
prices  which  has  been  so  conspicuous  among  the  economic 
phenomena  of  the  last  twenty  years.  To  that  fall  they  ascribe 
two  evils :  first,  an  unjust  increase  in  the  burdens  of  debtors ; 
and,  second,  a  check  to  enterprise  and  to  the  efficient  working 
of  the  productive  machinery  of  the  community.  The  increase 
in  the  burdens  of  debtors  is  one  which  all  economists  have 
pointed  to  as  the  result  of  a  general  fall  in  prices,  or  rise  in 
the  value  of  the  circulating  medium.  The  debtor  who  borrows 
a  hundred  dollars  now,  and  repays  them  five  years  hence,  when 
all  prices  have  fallen,  gives  back  more  than  he  received.  On 
debts  running  for  short  periods  of  time,  changes  in  general 
prices  are  not  likely  to  be  great  enough  to  cause  serious  hard- 


THE  ARGUMENT  FOR  SILVER  95 

ship ;  but  on  debts  running  over  long  periods  the  loss  to  debtors 
and  the  gain  to  creditors  will  be  great  and  continuing.  But 
such  a  steady  and  continuous  fall,  it  is  urged,  has  taken  place 
since  1873;  and  the  fall  is  likely  to  continue  further,  and  to 
renew  its  hardships  on  each  new  act  of  borrowing,  because  its 
cause  is  a  permanent  one.  That  cause  is  found  in  the  growing 
scarcity  of  gold,  which  has  been  selected  as  the  sole  standard 
of  value  among  civilised  countries.  The  production  of  gold, 
after  having  increased  with  great  rapidity  in  the  twenty  years 
following  the  Calif ornian  and  Australian  discoveries  in  1850, 
has  gone  on  but  slowly  since  1870.  Meanwhile,  the  popula- 
tion of  the  civilized  countries,  their  wealth,  their  production 
of  commodities  to  be  exchanged,  have  increased  with  extra- 
ordinary rapidity;  while  the  adoption  of  the  gold  standard  by 
Germany  in  1873,  and  the  resumption  of  specie  payments  by 
the  United  States  in  1879  and  by  Italy  in  1883,  have  added  to 
the  demands  for  which  the  scanty  annual  supply  of  gold  must 
suffice.  Hence  the  general  fall  in  prices;  in  other  words,  the 
appreciation  of  gold. 

The  second  effect  of  the  appreciation  of  gold,  in  checking 
industrial  progress  and  promoting  industrial  depression,  has 
been  less  insisted  on  in  the  United  States  than  in  European 
countries.  The  classic  economists  had  generally  reasoned 
that  a  general  rise  or  fall  in  prices  was  indifferent,  except  in 
regard  to  the  relations  of  debtor  and  creditor.  If  money  be- 
came scarce,  if  its  value  rose  and  all  prices  fell,  every  producer, 
to  be  sure,  would  receive  a  smaller  money  income  than  be- 
fore, and  would  have  a  smaller  money  capital.  But  he  would 
be  able  to  buy  as  many  commodities  and  as  much  labor  as 
before,  and  would  be  in  reality  just  as  rich  and  prosperous. 
In  the  middle  of  the  eighteenth  century,  when  economic 
thought  was  just  beginning  to  assume  its  modern  form,  David 
Hume  had  argued  that  though  a  fall  in  prices  is  at  bottom  in- 
different to  everybody  (except  as  debtor  or  creditor),  it  would 
yet,  in  its  effects  on  men's  spirits  and  expectations,  which  are 
all  connected  with  money  and  writh  terms  of  money,  exert  a 
depressing  influence  on  industry,  and  would  so  be  harmful; 
while  rising  prices,  though  also  really  indifferent  to  all,  \vould 
stimulate  hope  and  confidence,  and  so  arouse  to  more  active 


96       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

exertion  and  more  plentiful  production.  The  younger  Mill, 
in  his  Political  Economy,  thought  it  worth  while  to  enter  on  a 
careful  refutation  of  Hume's  reasoning.  But  the  bimetallists 
of  our  time  are  disposed  to  agree  with  the  shrewd  Scotchman. 
They  say  that  the  active  manager  of  industry,  the  business 
man  or  entrepreneur,  in  the  first  place  is  always  more  or  less  in 
debt ;  in  the  second  place,  is  always  buying  labor,  or  materials, 
or  goods,  with  the  intention  of  selling  a  product  at  a  later 
date  at  an  advance  in  price.  He  habitually  measures  his  gains 
in  terms  of  money,  and  not  in  terms  of  the  commodities  he 
can  buy  with  the  money.  In  times  when  prices  are  falling,  he 
finds  it  harder  to  meet  his  debts,  and  to  dispose  of  his  goods 
in  hand  at  a  money  advance  over  what  they  cost  him.  But 
the  business  man,  or  entrepreneur,  in  our  day  is  the  director 
and  initiator  of  industry.  He  employs  -labor,  borrows 
capital,  sets  the  wheels  of  industry  in  motion;  it  is  his  ex- 
pectations and  fears  and  hopes  which  determine  primarily 
whether  the  investment  of  capital  shall  take  place  in  large  or 
small  amount,  and  whether  the  machinery  of  production  shall 
move  smoothly  and  effectively,  or  slowly,  hesitatingly,  ineffi- 
ciently. The  argument  certainly  does  not  lack  plausibility; 
nor  can  it  be  said  to  have  often  been  squarely  met.  No  doubt 
it  takes  the  form,  in  the  United  States,  more  frequently  of 
confused  encomiums  on  the  inspiriting  effects  of  plentiful 
money,  than  of  direct  reasoning  as  to  the  ill  effects  of  too 
little  money,  such  as  I  have  endeavored  to  state  with  fairness 
in  the  preceding  sentences.  Yet  it  does  not  lack  weighty  back- 
ing. So  eminent  an  economist  as  President  Francis  A.  Walker 
has  .  .  .  insisted  on  the  evils  of  a  deficient  supply  of  money 
as  strangling  the  arteries  of  industrial  life. 

On  the  whole,  however,  the  other  argument,  bearing  on  the 
increase  in  the  burdens  of  debtors  under  falling  prices,  has 
been  more  often  heard  in  the  United  States,  and  certainly  has 
been  of  more  effect.  Prosperity,  activity,  general  industrial 
advance,  have  been  in  this  country  so  great  and  so  obvious  that 
the  argument  as  to  any  check  to  industry  could  take  serious 
hold  only  in  occasional  periods  of  depression  or  slackened  ad- 
vance. The  burden  on  American  debtors  from  falling  prices 
has  therefore  been  much  more  steadily  complained  of,  chiefly  in 


IMPROVEMENTS  IN  PRODUCTION  97 

regard  to  the  debts  of  the  farmers  and  other  borrowers  on  a 
comparatively  small  scale.  No  doubt  there  are  other  debtors 
whose  burdens  are  affected  at  least  as  much,  notably  the  rail- 
ways, among  whom  the  practice  of  borrowing  heavily  on  long 
time  has  sometimes  had  its  serious  effects.  But  it  is  the  farmer 
whose  case  has  received  most  attention,  and  in  some  ways 
doubtless  has  deserved  it  most. 

The  discussion  of  the  relations  of  debtors  and  creditors 
under  the  gold  standard  has  led  to  some  further  conclusions  as 
to  the  "  honesty  "  of  the  gold  and  silver  standards.  Those 
who  oppose  a  silver  basis  speak  of  the  silver  dollar  as  a  "  dis- 
honest "  coin.  But  those  who  attack  the  gold  standard  retort 
that  the  really  dishonest  dollar  is  that  of  gold.  It  is  pointed 
out  by  them  that  the  fall  in  the  price  of  silver  which  has  taken 
place  since  1873  has  not  been  greater  than  that  in  the  prices 
of  commodities  generally.  As  compared  with  commodities, 
therefore,  silver  has  been  more  steady  in  value  than  gold.  The 
fall  in  the  gold  price  of  silver,  which  is  adduced  by  the  mono- 
metallists  to  show  that  silver  is  not  a  good  standard  of  value, 
is  said  to  be  the  very  thing  which  proves  it  to  be  a  good  stand- 
ard of  value;  for  a  given  amount  of  silver  will  buy  the  same 
amount  of  commodities,  roughly,  as  it  would  twenty  years 
ago,  while  a  given  amount  of  gold  will  buy  more.  If  debts  had 
been  expressed  in  terms  of  silver,  the  debtor  would  have  had 
to  repay  the  creditor  the  same  amount  of  commodities  that  he 
received  —  not  more  commodities,  as  he  has  had  to  do,  with 
debts  measured  and  repaid  in  terms  of  gold.  So  far  as  the 
attainment  of  the  closest  possible  approach  to  ideal  justice  is 
concerned,  a  silver  standard  would  have  served  the  purpose 
better  than  a  gold  one. 

THE   EFFECT    OF   IMPROVEMENTS    IN    PRODUCTION 

The  bimetallist  agitation  for  a  return  to  the  wider  use  of 
silver  concurrently  with  gold  first  became  prominent  in  the 
years  of  depression  which  followed  the  crisis  of  1873.  For 
some  time  those  who  opposed  it  took  the  ground  that  the  alleged 
evils  did  not  exist  —  that  in  fact  there  had  been  no  permanent 
fall  in  general  prices.  The  decline  in  the  years  after  1873 
was  supposed  to  be  simply  the  usual  reaction  from  the  rise  in 


98       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

prices  which  marks  a  period  of  speculative  activity.  It  was 
expected  that  the  upward  movement  of  the  next  period  of 
activity  would  bring  the  average  range  of  prices  as  high  as  it 
had  been  before.  The  general  revival  which  set  in  after  1879 
in  all  civilized  countries  did  indeed  check  the  downward 
tendency,  and  in  some  countries  brought  about  an  appreciable 
rise.  But  this  counter-movement  by  no  means  offset  the 
marked  fall  which  had  preceded  it;  and  in  any  case  it  soon 
came  to  an  end,  and  was  followed  by  a  new  fall,  which  has 
continued  with  no  considerable  interruption  to  the  present  time 
(1891).  It  is  true  that  some  part  of  the  fall  is  no  more  than 
a  recoil  from  the  abnormally  high  prices  of  the  years  1871-73. 
It  is  true,  also,  that  some  commodities  have  shown  a  tendency 
to  rise,  and  that  in  one  very  important  respect  —  in  money 
incomes  and  the  money  rate  of  wages  —  there  has  been  a  strik- 
ing exception  to  the  general  movement.  Further,  it  must  be 
borne  in  mind  that  even  the  lowered  level  which  has  now  been 
reached  cannot  be  described  as  abnormally  low,  being  still  as 
high  as  that  which  obtained  at  the  middle  of  the  present  cen- 
tury. But  on  the  whole,  the  fact  of  a  general  fall  in  the  prices 
of  commodities  during  the  last  fifteen  or  twenty  years  cannot 
be  denied.  The  fall  has  not  been  uninterrupted;  it  has  not 
been  so  rapid  or  general  as  to  bear  on  the  face  of  it  proof  of 
harmful  results ;  but  it  has  been  steady,  and,  in  the  opinion  of 
the  present  writer  at  least,  is  likely  to  continue  slowly  and 
steadily  for  some  time  to  come. 

Recently,  therefore,  those  who  combat  the  bimetallist  rea- 
soning have  taken  a  different  position.  They  have  reasoned 
that  while  prices  may  in  fact  have  gone  down,  the  fall  is  not 
due,  as  the  bimetallists  allege,  to  an  appreciation  of  gold.  It 
is  to  be  accounted  for,  they  say,  by  other  causes,  notably  by 
the  extraordinary  improvements  in  the  production  of  com- 
modities. New  inventions  and  the  perfecting  of  old  ones  have 
cheapened  almost  all  manufactured  articles.  Raw  materials 
and  food  products  have  been  cheapened  partly  by  the  discovery 
of  new  sources  of  supply,  and  partly  by  that  improvement 
which  has  been  transforming  the  industrial  situation  more 
radically  than  any  other  —  the  wonderful  cheapening  of 
transportation  by  railways  and  steamships,  which  has  made  the 


IMPROVEMENTS  IN  PRODUCTION  99 

resources  of  the  plains  of  our  West  and  of  the  sheep-runs  of 
Australia  available  for  the  supply  of  the  markets  of  London 
and  New  York. 

So  far  as  this  train  of  reasoning  undertakes  to  explain  the 
mode  in  which  the  fall  in  prices  has  been  brought  about,  it 
seems  to  me  impregnable.  But  in  so  far  as  it  endeavors  to 
disprove  the  appreciation  of  gold,  or  to  show  that  the  general 
fall  is  not  due  to  this  appreciation,  I  have  never  been  able  to 
see  its  force.  In  truth,  both  the  bimetallists  and  their  oppon- 
ents seem  to  confuse  the  question  when  they  speak  of  the 
appreciation  of  gold  as  causing  lower  prices.  The  apprecia- 
tion of  gold  is  the  general  fall  in  prices.  The  two  are  not 
related  as  cause  and  effect;  they  are  simply  two  names  for 
one  and  the  same  thing  —  namely,  a  different  rate  of  exchange 
between  gold  on  the  one  hand  and  commodities  in  general  on 
the  other,  by  which  the  same  amount  of  gold  buys  more  com- 
modities than  before.  When  the  general  fall  in  prices  is  ad- 
mitted, the  case  of  the  bimetallists  as  to  the  appreciation  of 
gold  is  established  once  for  all.  Improvements  in  the  produc- 
tion of  commodities  may  explain  how  it  happens  that  they  are 
more  abundant,  and  exchange  on  less  favorable  terms  with 
gold,  of  which  the  quantity  has  not  been  increased  by  new 
rich  mines  or  great  improvements  in  production ;  but  the  fact 
of  the  depreciation  of  commodities,  or  of  the  appreciation  of 
gold,  is  not  thereby  explained  away. 

Nevertheless,  the  improvements  in  production  do  seem  to  me 
to  have  an  important  bearing  on  the  question  in  hand :  a  bear- 
ing not  on  the  simple  fact  of  the  appreciation  of  gold,  but  on 
the  social  consequences  which  are  said  to  flow  from  it,  and 
therefore  on  the  questions  of  policy  which  are  here  under  con- 
sideration. A  moment's  thought  will  show,  for  example,  that 
a  general  increase  in  the  efficiency  of  labor  affects  very  ma- 
terially the  mode  in  which  a  fall  in  prices  acts  on  the  relations 
of  debtor  and  creditor.  If  A  borrows  from  B  a  hundred 
dollars,  repayable  in  five  years,  and  if  at  the  end  of  the  five 
years  prices  in  general  have  fallen  to  one-half  of  the  previous 
rates,  B,  in  paying  back  to  A  the  one  hundred  dollars,  clearly 
returns  twice  as  many  commodities  as  he  got.  But  if,  at  the 
same  time,  the  efficiency  of  laSor  has  been  doubled  by  im- 


100       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

provements  in  production,  B  can  produce  with  the  same  labor 
twice  as  many  commodities  as  before;  and  he  returns  to  A 
the  product  of  the  same  quantity  of  labor  as  he  received. 
The  classic  economists  and  the  socialists  (at  least  some  schools 
of  socialists)  have  maintained  alike  that  the  ideally  perfect 
standard  of  justice  in  the  exchange  of  commodities  and  serv- 
ices is  equality  of  sacrifice  or  labor;  that  if  things  so  ex- 
changed for  each  other  that  equal  sacrifice  got  the  same  reward, 
complete  justice  would  be  attained.  Applying  this  test  to  the 
relations  bf  debtor  and  creditor  in  the  case  supposed,  we  find  it 
not  one  of  hardship  to  the  debtor,  but  apparently  one  of  justice 
to  both  parties.  It  is  true  the  creditor  gets  more  commodities 
than  he  gave;  but  he  gets  the  product  of  the  same  amount  of 
labor  as  he  devoted  to  the  commodities  originally  lent;  and 
why  should  he  not  share  with  the  rest  of  the  community  the 
benefits  of  a  general  increase  in  the  productiveness  of  labor? 
This  line  of  reasoning  will  become  simpler  and  more  con- 
crete if  we  approach  it  from  another  point  of  view.  Reference 
has  already  been  made  to  the  most  striking  and  important  ex- 
ception to  the  general  tendency  of  prices  to  fall,  namely,  that 
money  wages  and  incomes  in  all  civilized  countries  have  shown 
a  tendency  not  to  fall,  but  to  rise.  Whether  the  incomes  of 
the  rich  have  increased  faster  than  those  of  the  poor,  or 
whether  the  movement  has  shown  itself  with  rough  uniformity 
for  all  classes,  is  immaterial  for  the  present  discussion.  The 
admitted  fact  of  a  general  upward  movement  alike  among 
rich,  middle  class,  and  poor  is  .the  significant  thing.  In  other 
words,  there  has  been  an  inverse  movement  of  money  wages 
and  of  the  prices  of  commodities,  the  one  going  up  while  the 
other  went  down.  Now,  such  an  inverse  movement  is  what 
must  take  place  in  case  of  any  real  improvement  in  material 
welfare.  The  only  concrete  way  in  which  civilized  people 
can  become  better  off,  is  by  being  able  to  buy  more  —  by  their 
money  incomes  going  further  in  the  purchase  of  commodities. 
The  improvement  may  take  the  forrn  either  of  higher  money 
incomes,  with  stationary  prices ;  or  that  of  stationary  incomes, 
with  lower  prices ;  or  the  intermediate  form  which  in  fact  seems 
to  have  occurred,  of  money  incomes  rising  somewhat  and 
prices  at  the  same  time  falling  sc:r.2what.  If  we  assume  a 


IMPROVEMENTS  IN  PRODUCTION  IOI 

monetary  supply  that  is  limited,  or  does  not  increase  as  fast 
as  improved  means  of  production  cause  the  quantities  of  com- 
modities to  increase,  one  or  the  other  of  the  two  forms  last 
mentioned  must  be  found. 

In  such  a  state  of  things  there  can  hardly  be  said  to  be  any 
real  hardship  for  the  debtor.  It  is  true  that  prices  have  fallen, 
and  that  the  money  he  repays  the  creditor  will  buy  more  goods 
than  it  did  when  the  loan  was  contracted ;  but  his  own  money 
income  has  risen,  or  at  least  has  not  fallen,  and  the  repayment 
of  the  loan  can  cause  him  no  special  hardship  • —  none  greater 
than  he  must  have  expected.  The  case  clearly  differs  funda- 
mentally from  that  of  a  simple  rise  in  the  value  of  money,  or 
general  fall  in  both  prices  apd  wages.  .  .  .  The  fall  in  prices  in 
the  United  States  since  1879,  and  that  in  European  countries 
in  the  period  since  1873,  are  the  result,  on  the  whole  and  in  the 
long  run,  of  ...  the  general  improvements  in  production; 
they  have  not  been  accompanied  by  a  fall  in  money  incomes, 
and  they  cannot  be  said  to  have  caused  an  increase  in  the 
burden  of  debtors. 

The  reasoning  of  the  preceding  paragraphs  bears  also  on  the 
second  part  of  the  bimetallist  indictment  —  that,  namely,  as  to 
the  depressing  effects  o'f  falling  prices  on  industrial  enter- 
prise. Whether  a  simple  rise  in  the  value  of  money, 
unaccompanied  by  any  other  circumstance,  would  have  the 
depressing  effects  which  the  bimetallists  predict  and  the  classic 
economists  deny,  is  a  question  radically  different  from  that 
which  in  fact  presents  itself.  It  may  be  that  in  this  simple 
case  the  bimetallists  might  prove  to  be,  in  some  degree  at  least, 
in  the  right,  and  that  the  classic  reasoning,  here  as  on  many 
other  subjects,  while  sound  in  the  long  run,  would  need  some 
qualifications  and  correction.  In  the  long  run,  no  doubt,  it  is 
immaterial  whether  prices  are  high  or  low,  whether  money 
returns  fall  or  rise ;  and  yet  it  might  turn  out  that  the  habitual 
association  of  gain  or  loss  with  "  making  money  "  would  cause 
a  period  of  simple  falling  prices  to  be  one  of  hesitating  invest- 
ment of  capital  and  unenterprising  conduct  of  business.  But 
what  the  world  in  fact  has  seen  has  been  the  complex  case  of 
a  fall  in  prices  accompanied  by  great  improvements  in  produc- 
tion. The  business  man  and  capitalist  has  had,  to  be  sure,  to 


102       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

deal  with  falling  prices;  but  the  same  amount  of  capital  and 
labor  has  turned  out  more  commodities  than  before ;  and  his 
total  money  returns,  so  far  from  declining,  have  generally  in- 
creased. The  money  incomes  of  the  managers  of  industry 
have  shown  the  same  upward  movement  as  the  money  incomes 
of  the  other  classes  in  society.  So  long  as  this  is  the  case,  it 
is  idle  to  talk  of  a  depressing  effect  on  enterprise  from  the  fall 
in  prices,  or  of  a  strangling  of  the  industrial  organism  from 
insufficiency  of  the  circulating  medium.  In  fact,  the  immedi- 
ate cause  of  the  fall  in  prices  has  been  the  pushing  on  the 
market  for  sale  of  larger  and  larger  quantities  of  commodities, 
produced  with  profit  at  lower  and  lower  cost:  a  state  of  things 
fortunate  for  the  community,  and  surely  not  depressing  for 
the  business  man.  .  .  . 

This  effect  on  the  entrepreneur  of  improvements  and  of 
falling  prices  combined,  doubtless  accounts  for  the  failure  of 
the  bimetallist  agitation  to  secure  any  appreciable  hold  in  the 
business  world.  The  bimetallists,  both  in  England  and  on 
the  Continent,  have  labored  zealously  to  engage  support 
among  the  business  men,  but  never  with  a  degree  of  success 
at  all  proportionate  to  the  energy  displayed.  The  simple  rea- 
son is  that  the  business  world  has  not  been  in  any  state  of 
chronic  depression.  In  the  tips  and  downs  of  industrial  activ- 
ity there  have  been  periods  which  seemed  to  confirm  the 
pessimistic  accounts  of  the  bimetallist  and  of  other  persons 
malcontent  with  the  present  order  of  things;  but  in  due  time 
the  tide  has  always  turned.  .  .  . 

On  the  whole,  then,  the  fall  in  prices,  when  considered  in 
connection  with  the  other  great  changes  which  have  accom- 
panied it,  does  not  afford  so  much  countenance  to  the  bi- 
metallist proposal  as  at  first  sight  it  seems  to.  The  rise  in 
money  incomes  and  the  improvements  in  production  disprove 
any  intolerable  burden  on  debtors,  and  make  it  highly  improb- 
able that  the  change  has  had  any  general  depressing  effect  on 
industry. 

THE    CASE   OF    THE    FARMER 

Nevertheless,  there  is  something  more  to  be  said,  in  explana- 
tion and  justification  of  the  discontent  with  falling  prices,  and 


THE  CASE  OF  THE  FARMER  103 

of  the  silver  agitation  which  rests  on  that  discontent.  While 
the  effects  of  the  fall  in  prices  on  debtors  as  a  class  and  on 
producers  as  a  whole  have  not  given  real  grounds  for  com- 
plaint, certain  particular  debtors  and  producers  have  undoubt- 
edly been  injured.  The  case  of  these  latter  have  given  plausi- 
bility to  the  general  arguments  of  the  bimetallists,  and,  what 
is  more  important  at  the  present  juncture,  has  given  strength 
to  the  movement  in  the  United  States  for  more  money  and 
more  silver. 

The  situation  will  be  best  understood  if  we  contrast  for  a 
moment  the  different  modes  in  which  the  improvements  in 
production  have  been  brought  about  in  manufacturing  indus- 
tries on  the  one  hand,  in  agriculture  on  the  other  hand.  In 
manufactures  the  improvements  have  been  better  machinery, 
new  processes,  labor-saving  inventions,  the  conduct  of  busi- 
ness on  a  larger  scale,  and  so  the  greater  and  more  effective 
division  of  labor.  In  agriculture  the  main  cause  of  cheaper 
production  has  been  different:  it  has  been  the  opening  up  of 
new  lands  and  new  sources  of  supply.  No  doubt  there  are 
important  exceptions  to  these  general  statements.  In  agri- 
culture there  have  been  advances  in  the  arts  —  new  plants, 
better  fertilizers,  improved  implements,  more  effective  ways 
of  cultivating  the  soil.  In  manufactures,  on  the  other  hand, 
there  have  been  important  changes  due  to  the  discovery  of  new 
and  rich  mines  of  materials,  such  as  coal,  iron,  copper.  But 
on  the  whole,  the  difference  holds  good.  In  agriculture  un- 
doubtedly the  opening  of  new  lands  through  the  improvements 
in  transportation  has  been  the  most  important  single  cause  at 
work.  The  cheapening  of  agricultural  products  has  been  due 
not  so  much  to  the  more  effective  use  of  the  soil  already  under 
cultivation,  as  to  the  development  of  soil  not  formerly  avail- 
able for  the  supply  of  the  market. 

The  changes  in  production  and  prices  have  consequently 
affected  the  producers  in  these  two  branches  of  production  in 
very  different  ways.  In  manufactures  all  alike  have  felt  them, 
and  have  been  able  to  accommodate  themselves  to  the  effects. 
No  doubt  the  shrewder  producers  adopt  improvements  and 
new  inventions  first,  and,  so  long  as  they  keep  in  the  lead,  have 
the  advantage  of  their  competitors.  They  gain  by  doing  a 


104       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

large  business  at  lower  prices,  while  for  the  time  being  their 
slower  competitors  lose.  But  new  processes  and  new  inven- 
tions spread  over  the  whole  field  in  no  long  time.  The  open- 
ing of  a  new  source  of  supply,  on  the  other  hand,  cheapens 
production  through  a  process  which  the  holders  of  the  old 
source  of  supply  cannot  avail  themselves  of.  If  wheat  is 
raised  in  large  quantities  in  Dakota,  the  price  goes  down  as 
effectively  as  if  the  wheat  fields  of  England  and  New  York 
had  suddenly  become  more  fertile;  but  as  those  wheat  fields 
produce  no  more  than  before,  the  farmer  or  land  owner  on 
the  old  soil  has  nothing  to  offset  the  lower  price.  This  is  the 
explanation  of  the  agricultural  distress  of  which  so  much  has 
been  heard  in  Europe  in  recent  years,  and  which  has  been  the 
main  occasion  of  the  revival  of  protectionist  feeling  in  France, 
Germany,  and  other  countries  of  the  Continent.  The  farmer 
on  the  old  lands  does  not  find  in  improvements  in  production 
any  compensation  for  lower  prices.  If  he  owns  the  land,  he 
must  pocket  the  loss,  and  perhaps  in  the  end  abandon  his  land 
and  turn  to  something  else;  such  has  been  a  common  case  in 
New  England.  If  he  is  a  tenant  on  the  land,  he  will  probably, 
after  a  period  of  struggle  and  hardship,  get  lower  rents,  leav- 
ing the  landlord  as  the  permanent  sufferer ;  such  has  been  the 
outcome  in  old  England.  If  he  was  in  debt  before  the  change 
took  place,  he  will  find  his  debts  growing  more  burdensome  as 
his  money  income  goes  down;  such  has  been  the  result  with 
many  a  Western  farmer. 

It  is  in  causes  of  this  sort  that  we  find  the  explanation,  in 
part  at  least,  of  the  restlessness  among  the  Western  farmers 
of  which  the  silver  agitation  is  one  sign.  The  fall  in  the 
prices  of  wheat,  corn,  and  other  staples  has  been  due  to 
enormously  increased  production  in  regions  which  were  for- 
merly out  of  reach  of  the  market :  in  India,  Australia,  Russia, 
as  well  as  in  California,  Dakota,  Washington,  Oregon,  and  the 
Far  West  generally.  .  .  . 

It  is  probable  that  some  of  the  complaints  in  regard  to  the 
burden  of  debt  on  the  fanners  are  simply  a  legacy  from  the 
old  days  of  inflated  paper  money.  Not  a  few  of  the  debts  of 
the  present  [1891]  go  back  to  the  years  before  1870,  when 
we  had  prices  high  in  terms  of  over-issued  paper  money. 


THE  CASE  OF  THE  FARMER  105 

These  debts  have  been  renewed  and  continued,  in  whole  or  in 
part ;  and  the  fall  in  prices  has  made  them  heavier  and  heavier 
to  bear.  The  evil  here  again  is  real,  and  a  remedy  is  now 
hard  to  find.  The  only  conclusion  which  can  be  laid  down 
with  perfect  conviction  is  that  we  should  make  sure  of  pre- 
venting the  recurrence  of  a  new  era  of  excessive  paper  money. 
.  .  .  Another  important  circumstance  is  the  general  transi- 
tion in  agricultural  methods  inevitable  in  those  western  states 
which  have  been  settled  for  a  generation  or  more.  When 
new  land  is  first  taken  into  cultivation  the  most  effective  use 
of  it  is  found  in  the  continuous  production  of  some  staple  crop 
like  wheat  and  corn,  which  ^can  be  grown,  so  long  as  the  cream 
of  the  soil  is  not  exhausted,  year  after  year  with  large  returns. 
After  a  while,  however,  the  land  begins  to  show  signs  of  ex- 
haustion. The  staple  crops  do  not  yield  as  largely  as  before, 
and  less  crude  methods  of  using  the  soil  must  be  resorted  to. 
Manures  have  to  be  applied,  and  the  rotation  and  selection  of 
crops  practised.  Meat  and  dairy  products,  vegetables,  fruits, 
and  the  miscellaneous  agricultural  articles,  must  take  their 
place  in  rural  economy.  This  change  has  been  carried 
through  very  largely  in  states  like  New  York,  Pennsylvania, 
and  Ohio.  In  the  heart  of  the  Mississippi  Valley  it  is  now 
under  way;  but  the  transition  is  trying,  and  to  some  of  the 
farmers  it  is  impossible.  A  good  share  of  the  American  agri- 
cultural population  has  been  so  steadily  bred  to  the  easy  and 
careless  use  of  virgin  soil  that  it  cannot  accommodate  itself  to 
more  intensive  methods.  It  is  constantly  moving  westward; 
settling  for  a  generation  in  one  spot,  and  then,  as  the  land 
shows  signs  of  exhaustion,  moving  farther  west.  The  more 
intelligent  and  versatile  stay  behind,  adapt  themselves  to  new 
conditions,  and  in  time  prosper  under  them.  The  least  active 
also  stay  behind,  and  flounder  hopelessly  in  the  old  ways.  But 
a  large  number  are  always  moving  west.  In  every  state  be- 
tween the  Alleghanies  and  the  Missouri  river  there  are  large 
tracts  formerly  cultivated  by  native  settlers,  who  have  sold 
their  lands,  as  they  showed  signs  of  giving  out,  to  German  or 
Swedish  immigrants.  These  latter  have  not  infrequently  paid 
good  prices  for  the  lands :  but  they  have  been  bred  to  intensive 
farming,  to  careful  and  varied  use  of  the  soil,  and  they  have 


106      THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

prospered  where  their  native  predecessors  have  been  un- 
willing or  unable  to  adapt  themselves  to  the  new  conditions. 
The  period  of  transition  is  a  hard  one  for  all  of  the  native 
farmers,  whether  they  stay  behind  or  move  on,  and  the  lesson 
of  using  the  soil  with  more  skill  and  care  is  learned  only  under 
the  pressure  of  necessity.  In  such  periods  all  sorts  of  remedies 
for  hard  times  make  their  appearance  and  have  their  run. 

THE  REPEAL  OF  THE  SHERMAN  SILVER  PURCHASE  ACT  AND 

THE  FINANCIAL  AND  ECONOMIC  CONSEQUENCES 

OF  SILVER  LEGISLATION 

1  For  fourteen  years,  1878-1892,  only  an  insignificant 
amount  of  gold  was  paid  out  of  the  Treasury  in  the  redemption 
of  legal-tender  notes ;  the  total  amount  of  gold  in  the  Treasury 
increased  almost  steadily  and  continuously  from  $140,000,000 
on  January  i,  1879,  to  $300,000,000  in  1891.  In  1890  the 
new  issue  of  Treasury  notes,  together  with  a  change  in  com- 
mercial conditions,  placed  heavy  burdens  upon  the  reserve, 
the  rapid  diminution  of  which  is  shown  in  the  following 
figures : 

Date  Net  gold  reserve 

June  30,  1890 $190,232,405 

June  30,  1891 1 17,667,723 

June  30,  1892 114,342,367 

June  30,  1893 95485,413 

June  30,  1894 64,873,025 

The  reasons  for  the  fall  in  the  gold  reserve  are  too  various 
and  complicated  to  be  treated  here:  the  failure  of  the  great 
English  banking-house  of  Baring  Brothers  in  1890  brought 
about  a  considerable  withdrawal  of  English  capital  invested  in 
the  United  States;  and  an  unhealthy  and  inflated  industrial 
development  in  this  country  was  stimulated  by  the  new  tariff. 
To  outward  appearances  the  country  was  very  prosperous; 
expenditures  were  large,  imports  increased,  and  a  failure  of 
the  crops  in  Europe  in  1891  enlarged  our  grain  exports.  For 
a  brief  season  only,  were  the  natural  effects  of  the  Sherman 
law  delayed;  Europe  soon  recovered,  American  exports  fell, 
and  in  the  six  months  ending  June  30,  1893,  the  balance  of 

1  Davis  R.  Dewey,  Financial  History  of  the  United  States,  pp.  442-455. 
Longmans,  Green  and  Company,  New  York,  1915. 


REPEAL  OF  THE  SHERMAN  LAW  IO7 

trade  against  the  United  States  was  $68,800,000.  The  tariff 
of  1890  was  followed  by  diminished  customs  receipts.  The 
revenue  from  customs  was  as  follows : 

1890 $229,668,000 

1891  219,522,000 

1892  177,452,000 

1893  203,355,000 

1894  131,818,000 

.  .  .  Fortunately  the  internal  revenue  receipts  maintained 
their  customary  level  with  something  to  spare;  but  increased 
appropriations,  due  largely  to  the  passage  of  a  dependent 
pension  bill  in  1890,  cut\deep  into  the  funds  of  the  Treasury. 
In  1890  the  surplus  was  $105,344,000;  in  1891,  $37,239,000; 
in  1892,  $9,914,000;  in  1893,  $2,341,000;  but  in  1894  ap- 
peared a  deficit  amounting  to  $69,803,000.  The  Treasury  had 
been  weakened  by  the  reluctance  of  Secretary  Windom  to  de- 
posit government  funds  in  national  bank  depositories,  and  by 
his  preference  to  rely  entirely  upon  the  purchase  of  bonds  for 
getting  money  back  into  circulation.  In  the  earlier  years  of 
Harrison's  administration,  bonds  were  purchased  freely  —  too 
generously  in  view  of  the  impending  strain  upon  the  resources 
of  the  Treasury. 

Another  element  of  concern  was  due  to  the  change  in  the 
kind  of  money  received  by  the  Government  in  the  payment  of 
revenue.  Before  the  passage  of  the  Sherman  Act  nine-tenths 
or  more  of  the  customs  receipts  at  the  New  York  custom-house 
were  paid  in  gold  and  gold  certificates;  in  the  summer  of  1891 
the  proportion  of  gold  and  gold  certificates  fell  as  low  as  12 
per  cent.,  and  in  September,  '1892,  to  less  than  4  per  cent. 
The  use  of  United  States  notes  and  Treasury  notes  of  1890 
correspondingly  increased.  .  .  . 

The  reason  for  this  substitution  of  notes  for  gold  was  partly 
due  to  a  reversal  in  Treasury  practice.  For  many  years  it  had 
been  the  custom  of  the  Sub-Treasury  in  New  York  to  settle 
its  clearing-house  balances  almost  exclusively  in  gold  or  gold 
certificates.  For  example,  in  the  fiscal  year  1889-1890  the 
Sub-Treasury  paid  gold  balances  to  the  banks  of  nearly  $230,- 
000,000,  and  in  the  next  year  $212,000,000.  The  banks  were 
thus  daily  supplied  with  gold  which  they  in  turn  could  furnish 


108      THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

to  their  customers  either  for  customs  purposes  or  export  de- 
liveries. In  August,  1890,  the  Treasury  began  the  policy  of 
using  .  .  .  the  new  Treasury  notes  in  the  settlement  of  New 
York  balances,  and  in  the  year  ending  June,  1891,  Secretary 
Foster,  apparently  convinced  of  the  need  of  a  larger  gold  re- 
serve to  support  the  credit  of  the  Treasury  notes,  increased  the 
use  of  the  older  United  States  notes  and  held  on  to  the  gold 
reserve.  The  unexpected  result  was  that  the  banks,  deprived 
of  their  usual  supply  of  gold  for  trade  purposes,  sought  for  it 
at  the  Treasury  by  the  presentation  of  government  notes.  .  .  . 

In  March,  1893,  Cleveland  for  a  second  time  entered  upon 
the  presidency.  He  demanded  as  the  first  condition  of  relief 
the  suspension  of  silver  purchases.  The  silver  advocates, 
however,  were  still  powerful  in  both  parties,  and  President 
Cleveland  was  at  a  disadvantage  in  not  having  the  undivided 
support  of  his  own  party.  Even  the  position  of  Secretary 
Carlisle  was  .  .  .  doubted:  it  was  publicly  declared  that  he 
stood  ready,  if  expediency  demanded  it,  to  redeem  the  Treas- 
ury notes  of  1890  in  silver  instead  of  gold,  and,  while  standing 
upon  the  letter  of  the  law  which  demanded  their  redemption 
in  coin,  practically  to  cut  asunder  the  parity  of  gold  and  silver 
which  had  thus  far  been  maintained.  Although  the  President 
attempted  by  a  specific  declaration  to  make  clear  the  harmoni- 
ous purpose  of  the  administration  that  redemption  would  con- 
tinue in  gold,  public  apprehension  would  not  be  allayed. 
Whatever  might  be  the  wishes  of  the  administration,  it  was 
feared  that  it  would  not  have  power  to  carry  them  out;  par- 
ticularly when  it  was  announced  in  April,  1893,  that  the  gold 
reserve  had  been  drawn  down  to  $96,000,000  by  redeeming 
the  Treasury  notes  of  1890. 

At  this  juncture  of  financial  and  commercial  difficulties,  in 
June,  1893,  the  British  Government  closed  the  mints  in  India 
to  the  free  coinage  of  silver.  The  price  of  silver  bullion  fell 
promptly  and  rapidly,  and,  while  such  a  decline  might  on 
another  occasion  have  produced  no  immediately  serious  conse- 
quences to  the  Treasury,  it  came  at  a  moment  when  public 
opinion,  at  least  in  the  Eastern  States,  was  aroused  to  a  belief 
that  the  entire  financial  problem  was  associated  with  the  coin- 
age of  silver;  and  it  thus  furnished  one  of  the  contributory 


REPEAL  OF  THE  SHERMAN  LAW  IOQ 

forces  which  drove  the  commercial  community  into  a  state 
of  panic. 

It  was  not  until  June  30,  1893,  when  the  panic  was  well 
under  way,  that  a  special  session  of  Congress  was  called  for 
August  7 ;  only  by  the  most  strenuous  efforts  could  an  adequate 
support,  composed  of  elements  in  both  political  parties,  be 
rallied  to  uphold  the  President's  insistence  that  purchases  of 
silver  by  the  Government  should  cease.  The  House  quickly 
acquiesced,  and  on  August  21,  by  a  vote  of  239  to  108,  passed 
a  bill  for  the  repeal  of  the  purchasing  clause;  but  the  Senate 
was  stubborn,  and  not  until  October  30  could  a  favorable  vote, 
43  to  32,  be  secured.  So  far  as  the  Treasury  was  concerned, 
the  mischief  had  been  done ;  although  the  Government  was  re- 
lieved from  further  purchase  of  silver  which  increased  the 
volume  of  the  obligations  to  be  supported  by  gold,  the  old 
burdens  still  were  sufficiently  heavy,  in  connection  with  the 
low  state  of  commerce  and  industry,  to  exhaust  its  immediate 
revenues.  Thus  on  December  i,  1893,  the  actual  net  balance 
in  the  Treasury  above  the  gold  reserve,  pledged  funds,  and 
agency  accounts  was  only  $11,038,448.  Trade  and  industry 
had  been  disorganized;  the  panic  of  1893  extended  into  every 
department  of  industrial  life.  In  December,  1893,  the  Comp- 
troller of  the  Currency  announced  the  failure  during  the  year 
of  158  national  banks,  172  state  banks,  177  private  banks,  47 
savings  banks,  13  loan  and  trust  companies,  and  6  mortgage 
companies.  Some  of  these  institutions  afterwards  resumed 
business,  but  the  permanent  damage  was  great.  The  fright 
of  depositors  was  general  and  the  shrinkage  in  deposits  enorm- 
ous; bank  clearings  were  the  lowest  since  1885  ;  clearing-house 
loan  certificates  were  once  more  resorted  to,  this  time  on  a 
much  larger  scale  than  ever  before,  and  extended  to  cities 
throughout  the  country. 

The  production  of  coal,  both  anthracite  and  bituminous,  fell 
off;  the  output  of  pig-iron,  which  had  been  about  9,157,000 
tons  in  1892,  fell  to  6,657,000  tons  in  1894;  new  railway  con- 
struction almost  ceased;  in  1894  there  were  156  railways, 
operating  a  mileage  of  nearly  39,000  miles,  in  the  hands  of 
receivers;  among  these  were  three  great  railway  systems, — 
the  Erie,  Northern  Pacific,  and  Union  Pacific.  The  total 


1 10      THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

capitalization  in  the  hands  of  receivers  was  about  $2,500,- 
000,000,  or  one-fourth  of  the  railway  capital  of  the  country. 
The  earnings  of  railroads  and  the  dividends  paid  to  stock- 
holders were  seriously  affected;  securities  fell  to  one-half  and 
even  one-quarter  their  former  value;  commercial  failures  in- 
creased from  10,344  in  1892,  with  liabilities  of  $114,000,000, 
to  15,242  in  1893,  with  liabilities  of  $346,000,000.  The  prob- 
lem of  the  unemployed  became  general;  special  committees 
were  organized  in  nearly  all  of  the  large  cities  to  provide  food, 
and  in  many  places  relief  work  by  public  bodies  was  instituted. 
In  the  spring  of  1894  general  want  and  distress  led  to  labor 
strikes  and  riots,  as  in  Chicago,  and  even  to  more  abnormal 
outbreaks,  as  seen  by  the  march  of  Coxey's  army  of  unem- 
ployed from  Ohio  to  Washington.  The  distress  was  increased 
by  the  failure  of  the  corn  crop  in  1894;  the  demand  for  wheat 
in  Europe  fell  off  and  wheat  was  sold  on  the  Western  farm 
for  less  than  fifty  cents  a  bushel. 

SALE   OF   BONDS   FOR  GOLD 

Under  these  adverse  conditions  it  was  inevitable  that  the 
revenues  of  the  Government  should  continue  to  decline.  In 
the  six  months,  January  to  June,  1893,  the  excess  of  expendi- 
tures over  receipts  was  $4,198,000,  and  during  the  fiscal  year 
ending  June  30,  1894,  this  excess  increased  to  $69,803.000.  It 
was  even  necessary  to  encroach  upon  the  gold  reserve  for  cur- 
rent expenses,  and  for  months  this  fund  was  far  less  than 
caution  and  prudence  demanded.  When  the  integrity  of  the 
gold  reserve  was  first  assailed,  both  Secretary  Foster,  in  the 
closing  months  of  Harrison's  administration,  and  Secretary 
Carlisle,  at  the  beginning  of  Cleveland's  term,  endeavored, 
with  some  success,  to  tide  over  emergencies  by  appealing  to  the 
banks  to  exchange  gold  for  legal  tenders.  The  banks  recog- 
nized that  the  instability  of  Government  credit  seriously  af- 
fected the  value  of  all  securities  in  which  they  were  interested ; 
and  in  February,  1893,  they  handed  over  to  the  Treasury  about 
$6,000,000  in  gold,  and  in  March  and  April  about  $25.000,000 
more.  The  expedient  was  not  enough  to  stop  the  con- 
tinued drain  upon  the  Treasury.  At  the  very  moment  that  the 
Government  was  relieved  of  notes  through  the  exchange  of 


SALE  OF  BONDS  1 1 1 

gold  by  the  banks,  other  notes  were  presented  to  the  Treasury 
for  redemption,  largely  to  draw  gold  for  exportation  in  the 
settlement  of  trade  balances.  .  .  . 

The  only  way  to  protect  the  fund  of  gold  reserve  under  the 
circumstances  was  borrowing  —  that  is,  the  sale  of  bonds  for 
gold  —  yet  some  people  who  were  opposed  to  the  overthrow 
of  the  gold  standard  consistently  urged  that  borrowing  be  post- 
poned until  the  last  moment,  so  as  to  add  as  little  as  possible 
to  the  resources  available  for  purchases  of  silver.  Some  of 
the  gold  party  would  even  have  permitted  the  drain  to  go  on 
to  the  end,  notwithstanding  the  inevitable  evils,  in  the  belief 
that  the  country  could  be  convinced  of  its  errors  in  no  other 
way. 

Eventually,  to  prevent  a  suspension  of  specie  payments  in 
gold,  the  Treasury  Department  made  successive  issues  of 
bonds  for  the  purchase  of  gold.  These  issues  are  very  inter- 
esting to  the  student  of  finance.  No  administration  wishes  to 
add  to  public  indebtedness  in  times. of  peace;  and  Secretary 
Carlisle  had  scruples  against  selling  bonds,  except  with  the 
authority  of  the  Congress  then  sitting;  hence  the  issue  of 
bonds  was  put  off  to  the  last  possible  moment.  The  only 
existing  authority  for  selling  bonds  was  the  resumption  act 
of  1875 ;  this  provided  only  for  ten-year  5  per  cent.,  fifteen- 
year  4l/2,  and  thirty-year  4  per  cent,  bonds,  all  of  which  would 
command  a  premium  so  high  as  to  diminish  their  attractiveness 
as  an  investment,  and,  taken  in  connection  with  the  length  of 
time  which  they  ran,  to  hamper  the  Treasury  in  purchasing  or 
refunding  the  debt  when  the  crisis  was  over.  The  administra- 
tion asked  for  the  issue  of  low-rate  bonds,  but  Congress,  in- 
spired in  part  by  free  silver  arguments,  and  in  part  by  political 
intrigues  to  discredit  the  administration,  paid  no  attention  to 
the  recommendation  of  the  Secretary.  Finally,  in  January, 
1894,  without  special  legislation,  but  under  the  ancient  au- 
thority of  the  resumption  act,  $50,000,000  of  5  per  cent,  ten- 
year  bonds  were  sold,  yielding  $58,660,917;  and  again  in 
November  an  equal  amount  of  bonds  with  like  conditions  were 
marketed,  yielding  $58,538,500.  The  sale  of  the  first  issue 
was  on  the  whole  creditable,  considering  that  at  about  the  same 
time  the  President  was  obliged  to  veto  a  bill  providing  for 


112       THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

coining  the  silver  seigniorage,  and  that  an  effort  had  been  made 
in  the  courts  to  enjoin  the  Secretary  of  the  Treasury  from 
selling  bonds  under  the  law  of  1875. 

In  each  case  the  sale  of  bonds  called  for  subscriptions  in 
gold,  but  the  new  supplies  were  quickly  exhausted  by  fresh  re- 
demption of  notes.  The  fluctuations  in  the  volume  of  gold  in 
the  Treasury  as  a  consequence  of  the  bond  sales  is  seen  in  the 
following  figures : 

Date  Gold  in  Treasury 

January    31,    1894 $65,650,000 

February  10,  104,1 19,000  Bond  issue. 

November  20,  "     59,054,000 

November  30,  "     105,424,000  Bond  issue. 

February  9,  1895 4I,393,OOO 

The  endless  chain  appeared  to  be  in  full  and  unceasing 
operation ;  not  only  was  gold  being  withdrawn  for  export  but 
also  for  individual  hoarding,  in  fear  of  an  impending  sus- 
pension of  gold  payments'.  The  Treasury  finally  recognized 
the  futility  of  selling  bonds  for  gold,  most  of  which  was 
drawn  out  of  the  Treasury  itself,  by  the  presentation  of  legal- 
tender  notes  for  redemption.  A  new  device  was  tried :  in 
February,  1895,  the  Secretary  of  the  Treasury  entered  into 
a  contract  with  certain  bankers  for  the  purchase  of  3,500,000 
ounces  of  standard  gold  at  the  price  of  $17.80441  per  ounce, 
to  be  paid  for  by  the  delivery  of  United  States  bonds  having 
thirty  years  to  run  and  bearing  4  per  cent,  interest;  not  less 
than  one-half  of  this  gold  was  to  be  procured  abroad,  and  the 
parties  with  whom  the  contract  was  made  stipulated  that  they 
would  "  as  far  as  lies  in  their  power  exert  all  financial  influ- 
ence and  make  all  legitimate  efforts  to  protect  the  Treasury 
of  the  United  States  against  the  withdrawals  of  gold,  pending 
the  complete  performance  of  this  contract."  An  ounce  of 
standard  gold  was  worth  $18.60465,  and  the  difference  be- 
tween that  sum  and  the  contract  price  represented  the  premium 
received  by  the  Government  on  the  bonds,  making  the  price 
at  which  the  bonds  were  accepted  $104.4946.  A  condition  was 
affixed  to  the  contract,  by  which,  in  case  Congressional  au- 
thority could  be  secured,  a  3  per  cent,  gold  bond  might  be 
substituted,  and  for  this  the  syndicate  agreed  to  pay  a  higher 
price. 


SALE  OF  BONDS  113 

In  view  of  the  unfavorable  terms  of  the  bargain  imposed 
by  this  contract,  the  administration  hoped  that  Congress  would 
promptly  act  and  authorize  the  issue  of  the  lower  and  more 
remunerative  bond.  Faithful  in  its  adherence  to  silver,  Con- 
gress could  not  be  swerved;  it  defeated  the  bill  authorizing  the 
sale  of  a  low-rate  gold  bond,  and  then  engaged  in  an  angry 
debate  denouncing  the  Executive  for  his  subserviency  to  the 
gold  standard  banking  interests  in  entering  into  a  contract  not 
only  disgraceful  but  illegal.  In  reply  it  could  be  shown  that 
the  New  York  Sub-Treasury  was  within  forty-eight  hours  of 
gold  exhaustion.  .  .  . 

At  first  the  syndicate  was  successful,  because  of  some  slight 
improvement  in  trade,  but  later  it  practically  failed  to  control 
the  price  of  exchange.  It  once  more  became  cheaper  for  mer- 
chants to  ship  gold  than  to  purchase  bills,  and  gold  continued 
to  be  withdrawn  from  the  Treasury.  On  December  3,  1895, 
the  gold  reserve  stood  at  $79,333,000,  and  after  the  commercial 
apprehension  caused  by  President  Cleveland's  Venezuelan 
message  a  fortnight  later,  the  reserve  was  still  further  reduced. 
Once  more  the  administration  resorted  to  a  bond  sale,  and 
again  the  action  was  preceded  by  a  special  message  from  the 
President  to  Congress  asking  for  a  grant  of  authority  to  issue 
gold  bonds  instead  of  coin  bonds,  and  also  for  the  retirement 
of  the  legal-tender  notes  which  continued  in  an  endless  chain 
their  journey  to  the  Treasury,  and  drove  off  gold  to  the  com- 
mercial market.  As  Congress  still  refused  to  act,  the  Treas- 
ury resorted  to  a  fourth  issue  of  $100,000,000  4  per  cent, 
bonds.  The  Treasury  now  carefully  avoided  any  appearance 
of  dealing  through  a  syndicate  and  publicly  advertised  for 
offers,  with  the  encouraging  result  of  4,640  bids,  amounting  to 
$684,262,850.  Seven  hundred  and  eighty-one  bids  were  ac- 
cepted and  the  premium  yielded  about  $11,000,000.  The 
relief  obtained  by  the  Treasury,  however,  was  meagre,  for  it  is 
estimated  that  $40,000,000  of  the  bonds  were  purchased  with 
gold  withdrawn  from  the  Treasury  by  the  redemption  of  notes. 
This  was  the  Government's  penalty  for  its  endeavor  to  sep- 
arate itself  from  all  dealings  with  a  banking  syndicate. 

In  spite  of  this  sale  of  bonds  the  reserve  remained  near  the 
traditional  danger  line.  In  July,  1896,  it  fell  to  $90,000,000 


114      THE  SILVER  QUESTION  IN  THE  UNITED  STATES 

because  of  hoarding  due  to  popular  apprehension  as  to  the 
success  of  the  silver  movement  in  the  November  presidential 
election.  Fearful  that  a  new  bond  issue  might  strengthen  the 
claims  of  the  silver  advocates,  bankers  and  dealers  in  foreign 
exchange  voluntarily  combined  to  support  the  Treasury  by 
exchanging  gold  for  notes.  The  effort  succeeded,  and  the 
reserve  was  placed  in  safety.  After  the  elections  in  November 
gold  came  out  from  its  hiding-places,  and  was  turned  into  the 
Treasury  in  large  amounts.  Business  and  revenue  improved 
and  the  difficulties  of  the  Treasury  Department  were  tided 
over. 

Many  Republicans  held  the  earnest  conviction  that  the  issue 
of  bonds  would  not  have  been  necessary  if  the  revenue  had  been 
sufficient.  Not  only  had  industry  and  commerce  been  un- 
settled by  the  tariff  act  of  1894,  but  the  operations  of  the 
endless  chain  must  certainly  continue,  it  was  held,  until  there 
was  a  generous  income  in  excess  of  expenditures,  whereby  a 
considerable  part  of  the  credit  currency  might  be  covered  into 
the  Treasury  and  thus  lessen  the  possible  claims  for  redemp- 
tion. The  administration  emphatically  replied  that  at  no 
time  when  bonds  were  issued  was  there  intention  of  paying 
the  expenses  of  the  Government  with  their  proceeds,  and  that 
the  Treasury  Department  had  no  authority  whatever  to  issue 
bonds  for  such  purposes.  President  Cleveland  was  insistent 
that  on  each  occasion  of  a  bond  issue  there  were  sufficient  funds 
in  the  Treasury  to  meet  the  ordinary  expenditures  of  the  Gov- 
ernment. The  proceeds  of  the  bonds  sold  for  the  mainten- 
ance of  the  national  credit  were,  however,  turned  into  the 
general  fund  of  the  Treasury,  and  consequently,  though  not 
originally  designed  for  that  purpose,  employed  to  meet  indis- 
criminately all  demands  made  upon  the  Government,  whether 
for  redemption  of  notes  or  the  payment  of  debts.  .  .  .  There 
was  a  series  of  deficits  beginning  with  1894,  but  the  deficit 
by  no  means  equalled  the  amounts  of  bonds  sold. 


CHAPTER  VIII 
INDEX  NUMBERS 

1  INDEX  numbers  are  used  to  indicate  changes  in  the  value 
of  money.  The  objects  for  which  this  measurement  is  under- 
taken are  thus  well  stated  by  Sir  R.  Giffen  (Second  Report 
of  the  committee  appointed  for  the  purpose  of  investigating 
the  best  method  of  ascertaining  and  measuring  variations  in 
the  value  of  the  monetary  standard.  Report  of  the  British 
Association,  1888)  :  (i)  The  fixation  of  rents  or  other  de- 
ferred payments  extending  over  long  periods  of  time,  for  which 
it  has  been  desired  to  obtain  a  currency  of  a  more  stable  sort 
than  money  is  supposed  to  be.  (2)  To  enable  comparisons 
to  be  made  between  the  value  of  money  incomes  in  different 
places,  which  is  often  an  object  of  great  practical  interest;  not 
only  individuals  contemplating  residential  changes,  but  also 
governments  and  other  large  spending  bodies,  spending  money 
in  widely  distant  places,  having  to  consider  this  question. 
(3)  To  enable  historians  and  other  students  making  compari- 
sons between  past  and  present  to  give  an  approximate  mean- 
ing to  the  money  expressions  which  they  deal  with,  and  say 
roughly  what  a  given  fine,  or  payment,  or  amount  of  national 
revenue  or  expenditure  in  a  past  age  would  mean  in  modern 
language.  To  which  some  would  add:  (4)  To  afford  a 
measure  of  the  extent  to  which  trade  and  industry  have  been 
injuriously  affected  by  a  variation  in  prices;  and  of  the  cor- 
rection which  it  would  be  desirable  to  apply  to  the  currency. 

An  index  number  is  constructed  by  combining  several  items, 
each  of  which  is  a  ratio  between  the  price  of  a  certain  article 
at  a  particular  date  under  consideration  (e.  g.,  last  year  or 
month)  and  the  price  of  the  same  article  at  a  period  taken  as 
base  or  standard  (e.  g.,  1867—77,  in  the  index  number  con- 

1  Dictionary  of  Political  Economy,  edited  by  R.  H.  T.   Palgrave.    Vol. 
II,  pp.  384-7.     Macmillan  and  Company,  Limited.     London.     1912. 

•    "5 


Il6  INDEX  NUMBERS 

structed  by  Mr.  Sauerbeck,  Journal  of  the  Statistical  Society, 
1886  and  1893).  These  ratios  are  generally  expressed  as 
percentages.  E.  g.,  the  percentage  for  flour  in  1885,  as  given 
by  Mr.  Sauerbeck,  is  63;  meaning  that  the  price  of  flour  in 
1885  is  to  the  average  price  of  the  same  article  in  1867-77  as 
63  :  100.  The  term  index  number  is  sometimes  applied  (c.  g., 
by  Mr.  Sauerbeck,  op.  cit.)  to  each  of  these  items,  as  well  as 
to  their  combination. 

The  percentages  are  usually  compounded  by  taking  an 
AVERAGE  of  them.  But  a  result  of  equal  generality  may 
be  obtained  by  taking  their  sum.  One  of  the  best-known  in- 
dex numbers,  that  of  the  Economist,  is  thus  constructed. 
Twenty-two  articles  having  been  selected,  the  price  of  each 
article  at  the  current  date  compared  with  its  price  at  the  stan- 
dard period  (1845—50)  is  expressed  as  a  percentage;  and  the 
sum  of  these  percentages  is  put  as  the  index  number.  Thus 
the  Economist  index  number  for  the  year  1873  is  2947;  such 
a  sum  is  easily  reduced  to  the  form  of  an  average  by  simple 
division  (e.  g.,  2947-7-22  =  134).  Accordingly  in  what  fol- 
lows it  will  be  sufficient  to  consider  the  latter  form  only. 

The  construction  of  an  index  number  presents  the  follow- 
ing problems:  (a)  What  are  the  commodities  of  which  the 
prices  are  to  be  taken?  (6)  How  are  the  prices  to  be  ascer- 
tained? (c)  How  are  the  ratios  between  the  prices  of  each 
article  at  the  current  and  the  standard  dates  to  be  combined? 

The  answers  to  these  questions  vary  according  to  the  pur- 
pose in  hand.  ...  As  appropriate  to  the  first  purpose,  a  stan- 
dard of  deferred  payments,  two  methods  present  themselves, 
viz.,  to  arrange  that  the  debtor  should  pay,  the  creditor  receive, 
either  ( i )  the  same  quantity  of  goods  and  services,  the  same 
amount  of  utility,  so  to  speak;  or  (2)  the  product  of  the  same 
quantity  of  labour  —  or  more  exactly  effort  and  sacrifice. 

Of  these  methods  the  former  has  been  more  generally  ac- 
cepted. It  is  adopted  for  instance  by  the  British  Association 
Committee  already  referred  to,  as  par  excellence  the  measure 
of  the  change  in  the  value  of  the  monetary  standard.  The 
former  method  is  indeed  more  intelligible.  However,  in 
favour  of  the  latter  there  are  some  weighty  considerations  and 
authorities.  It  seems  to  be  the  nearest  possible  approach  to 


METHODS  OF  WEIGHTING  II? 

Ricardo's  conception  of  a  commodity  invariable  in  value, 
"  which  at  all  times  requires  the  same  sacrifice  of  toil  and 
labour  to  produce  it."  (Principles,  iii.  ch.  xx.,  "  On  Value  and 
Riches,"  cp.  Mill,  bk.  iii.  ch.  xv.,  "  On  a  Measure  of  Value.") 
"  A  standard,"  says  Mr.  Leonard  Courtney,  "  should  be  some- 
thing which  as  far  as  possible  involves  the  same  labour  and  the 
same  sacrifice  in  obtaining  it"  (Nineteenth  Century,  March, 
1893).  Prof.  Marshall,  in  his  evidence  before  the  royal  com- 
mission on  gold  and  silver,  says,  speaking  of  appreciation  of 
gold :  "  When  it  is  used  as  denoting  a  rise  in  the  real  value 
of  gold,  I  then  regard  it  as  measured  by  the  diminution  in  the 
power  which  gold  has  of  purchasing  labour  of  all  kinds  — 
that  is,  not  only  manual  labour,  but  the  labour  of  business  men 
and  all  others  engaged  in  industry  of  any  kind"  (Question 
9625). 

If  the  first  method  is  adopted,  the  answers  to  the  questions 
above  set  are  as  follows:  (a)  The  commodities  of  which  the 
prices  are  to  be  taken  should  be  articles  of  consumption  rather 
than  materials  and  implements.  Payments  for  personal  serv- 
ices should  be  included,  but  not  wages  in  general.  (&)  Retail 
prices  should  be  used,  (c)  The  proper  combination  of  the 
ratios  is  an  average  of  the  kind  technically  called  weighted. 
.  .  .  The  general  principle  according  to  which  the  weights  are 
to  be  assigned  is  that  they  should  represent  the  importance  of 
each  commodity  to  the  consumer.  But  this  idea  may  be  em- 
bodied in  different  plans. 

1.  One  plan  is  to  assign  as  the  weight  of  each  percentage, 
or  ratio  between  prices,  the  value  of  the  corresponding  com- 
modity at  the  initial  or  standard  period.     According  to  this 
plan  the  index  number  is  the  ratio  between  these  two  values : 
the  quantities  initially  consumed  at  the  prices  of  the  current 
date,  and  the  same  quantities  at  the  standard  prices.     This 
method  is  exemplified  by  Sir  R.  Giffen's  estimate  of  the  change 
in  the  value  of  money  between  1873  (and  1883)  and  earlier 
years,  in  his  report  on  prices  of  exports  and  imports,  1885, 
table  v. 

2.  Another  plan  is  to  assign,  as  the  relative  importance  of 
each  percentage,  its  value  at  the  particular  epoch,  the  current 
year.     This  plan  is  adopted  by  Mr.  Palgrave  in  his  memoran- 


Il8  INDEX  NUMBERS 

dum  on  Currency  and  Standard  of  Value  ...  in  the  third 
report  of  the  royal  commission  on  depression  of  trade  and 
industry,  table  xxvii. 

3.  According  to  another  plan,  the  index  number  is  the  ratio 
between  the  following  two  values:  the  quantities  consumed 
at  the  current  date  at  the  current  prices,  and  the  same  quanti- 
ties at  standard  prices.     This  plan  is  adopted  by  Mr.  Sauer- 
beck (Journ.  Stat.  Soc.,  1886,  p.  595). 

4.  Or,  instead  of  taking  either  the  initial  quantities  or  those 
of  the  current  date,  a  mean  between  the  two  may  be  taken. 
This  is  the  plan  adopted  by  the  British  Association  Commit- 
tee.    They  estimate  "  the  average  national  expenditure   on 
each  class  of  article  at  present  and  for  the  last  few  years  " ; 
and  put  for  the  relative  importance  of  each  commodity  a  round 
number  corresponding  to  that  estimate.     Thus  the  estimated 
.expenditure  per  annum  on  wheat  is  £60,000,000,  and  on  meat 
£100,000,000:  that  is  respectively  6.5  per  cent.,  and  n  per 
cent,  of  the  sum  of  the  corresponding  estimates  for  all  the 
commodities  utilized  by  the  committee.     As  convenient  ap- 
proximations, the  weights  five  and  ten  are  recommended  by 
the  committee. 

If  the  index  number  based  on  labour  .  .  .  rather  than  on 
consumption,  is  adopted  as  the  standard  for  deferred  payments, 
it  would  be  proper  by  analogy  to  take  as  the  measure  of  ap- 
preciation or  depreciation  the  change  in  the  pecuniary  remu- 
neration of  a  certain  set  of  services,  namely  all,  or  the  prin- 
cipal, which  are  rendered  in  the  course  of  production  through- 
out the  community  during  a  year,  either  at  the  initial  or  the 
current  epoch;  or  some  expression  intermediate  between  the 
two  specified.  But  it  may  be  doubted  whether  the  statistics 
requisite  for  this  method  are  available. 

With  regard  to  the  second  and  third  of  the  purposes  above 
enumerated,  the  determination  of  the  comparative  value  of 
money  at  dis'fant  places  and  remote  times  —  one  or  other  of 
the  two  methods  indicated  would  seem  to  be  theoretically 
proper. 

For  the  fourth  purpose,  the  regulation  of  currency,  the 
proper  construction  of  the  index  number  would  seem  to  be 
as  follows :  (a)  The  "  articles  "  of  which  the  prices  are  taken 


AVERAGES  1 19 

into  account  should  be  both  commodities  and  services;  (b) 
both  wholesale  and  retail  prices  should  be  used;  (c)  the  rela- 
tive importance  of  each  article  should  be  proportioned  to  the 
demand  upon  the  currency  which  it  makes.  But  here  as  in 
other  parts  of  the  subject  theory  halts  a  little,  and  statistics 
lag  far  behind  theory. 

Considering  the  theoretical  doubts  and  statistical  difficul- 
ties which  attend  the  determination  of  weights  proper  to  each 
purpose,  there  is  much  to  be  said  in  favour  of  assigning  equal 
relative  importance  to  all  the  items;  especially  if  care  is  taken 
to  include  many  articles  such  as  corn,  cotton,  etc.,  which  for 
any  of  the  purposes  which  may  be  contemplated  must  be  of 
first-rate  importance.  Such  is  the  character  of  some  of  the 
principal  index  numbers  which  have  been  constructed  —  those 
of  the  Economist,  of  Jevons,  of  Soetbeer,  and  of  Mr.  Sauer- 
beck. 

In  the  construction  of  such  an  index  number  the  use  of  the 
arithmetic  mean  is  not  imperative.  Jevons  employs  the  geo- 
metric mean.  His  reasons  for  preferring  it  are  not  very  clear 
(the  "Variation  of  Prices,"  Currency  and  Finance,  p.  120). 
.  .  .  The  geometric  mean  has  also  the  advantage  of  being  less 
liable  than  the  ordinary  average  to  be  unduly  affected  by  ex- 
tremely high  prices  (Report  of  the  British  Association,  1887, 
p.  283).  The  great  objection  to  the  geometric  mean  is  its 
cumbrousness. 

There  is  another  kind  of  mean  which  has  some  of  the  ad- 
vantages of  the  geometric,  and  is  free  from  its  essential  disad- 
vantage; namely,  the  median  .  .  .  which  is  formed  by  ar- 
ranging the  items  in  the  order  of  magnitude,  and  taking  as  the 
mean  that  figure  which  has  as  many  of  the  items  above  as 
below  it.  For  instance  the  median  of  the  forty-five  percent- 
ages on  which  Mr.  Sauerbeck's  index  number  is  based  was, 
for  1892,  66 ;  while  the  arithmetic  mean  was  68.  It  is  difficult 
to  see  why  the  latter  result  is  preferable  to  the  former;  if  what 
is  required  is  an  index  of  the  change  in  general  prices,  not 
specially  referred  to  any  particular  purpose,  such  as  of  secur- 
ing a  constant  benefit  to  a  legatee. 

The  perplexity  of  a  choice  between  such  a  variety  of  methods 
is  much  reduced  by  the  two  following  considerations.  First, 


1 20  INDEX  NUMBERS 

beggars  cannot  be  choosers.  The  paucity  of  statistical  data 
(see  the  report  drawn  up  by  Sir  R.  Giffen  in  the  Report  of 
the  British  Association  for  1888,  p.  183)  restricts  the  opera- 
tion. Thus  for  the  purpose  of  index  numbers  based  on  con- 
sumption .  .  .  retail  prices  are  theoretically  appropriate;  but 
"  practically  it  is  found  that  only  the  prices  of  leading  com- 
modities, capable  of  being  dealt  with  in  large  wholesale  mar- 
kets, can  be  made  use  of  "  (Giffen,  loc.  cit.}.  Second,  the  dif- 
ference between  the  results  of  different  methods  is  likely  to 
be  less  than  at  first  sight  appears.  For  instance,  the  probable 
difference  between  the  index  number  constructed  by  the  British 
Association  committee,  and  six  others  which  have  been  pro- 
posed by  high  authorities  —  supposing  the  different  methods 
to  be  applied  to  the  same  data,  viz.,  the  prices  of  twenty-one 
articles  specified  by  the  Committee  may  thus.be  expressed. 
The  discrepancy  which  is  as  likely  as  not  to  occur  between 
the  committee's  and  other  results  is  from  2  to  2.5  per  cent. 
The  discrepancy  which  is  very  unlikely  to  occur  is  from  8 
to  ii  per  cent.  (Report  of  the  British  Association  for  1888, 
p.  217).  In  fact,  the  index  number  for  the  year  1885,  as  de- 
termined from  the  same  data  by  seven  different  methods, 
proved  to  be  70,  70.6,  73,  69,  72,  72,  69.5  (ibid.,  p.  211). 

The  practical  outcome  of  these  two  considerations  is  thus 
well  expressed  by  Giffen  (loc.  cit.  p.  184),  "The  articles  as 
to  which  records  of  prices  are  obtainable  being  themselves  only 
a  portion  of  the  whole,  nearly  as  good  a  final  result  may  ap- 
parently be  arrived  at  by  a  selection  without  bias,  according 
to  no  better  principle  than  accessibility  of  record,  as  by  a  care- 
ful attention  to  weighting.  .  .  .  Practically  the  committee 
would  recommend  the  use  of  a  weighted  index  number  of  some 
kind,  as,  on  the  whole,  commanding  more  confidence.  ...  A 
weighted  index  number,  in  one  aspect,  is  almost  an  unneces- 
sary precaution  to  secure  accuracy,  though,  on  the  whole,  the 
committee  recommend  it." 


CHAPTER  IX 
BANKING  OPERATIONS  AND  ACCOUNTS 

1  THE  intermediate  employed  in  actual  transactions  is,  in 
increasing  degree,  that   form  of  currency  called  credit,  the 
lowest  order  of  currency,  rather  than  money  itself.     Checks 
and  drafts  make  up  a  progressively  larger  share  of  the  cir- 
culating medium.     The  net  deposit  credits  in  the  national  banks 
in  the  United  States  —  to  say  nothing  of  the  other  banks  — 
are  double  the  volume  of  the  actual  money  in  the  country. 
And  a  large  share  of  this  actual  money  is  really  employed  as 
reserves  to  support  the  credit  circulation.     More  than  90  per 
cent,  of  the  larger  sorts  of  transactions  are  mediated  through 
the  use  of  deposit  credit,  and  probably  more  than  one-half  of 
the  remaining  transactions  are  similarly  effected.     Thus  the 
study  of  banking  is  essential  to  any  understanding  of  monetary 
problems.  .  .  . 

2  For  a  bank,  as  well  as  for  any  other  considerable  estab- 
lishment, it  is  requisite  that  a  capital  should  be  provided  at 
the  outset.     There  can  be  no  constant  proportion  between  the 
amount  of  this  capital  and  the  extent  of  the  business  which 
may  be  built  up  by  its  means.     We  can  only  say  that,  other 
things  being  equal,  the  larger  the  business  that  can  be  carried 
on  with  safety  with  a  given  capital,  the  larger  will  be  the  field 
from  which  profits  can  be  earned,  and  the  higher  the  proportion 
which  the  profits  will  bear  to  the  original  investment ;  but  the 
point  at  which  the  extension  of  the  business  passes  the  line  of 
safety,  must  be  determined  by  the  circumstances  of  the  particu- 
lar bank,  by  the  kind  of  business  carried  0,11  by  those  dealing 
with  it,  and  by  the  condition  of  the  community  in  which  it  is 

1  Herbert  Joseph  Davenport,  The  Economics  of  Enterprise,  pp.  259,  60. 
The   Macmillan   Company.     New   York.     1913. 

2  Charles  F.  Dunbar,  Chapters  on  the  Theory  and  History  of  Banking, 
pp.  20-38,  G.  P.  Putnam's  Sons,  New  York  and  London.     1902. 

121 


122  BANKING  OPERATIONS  AND  ACCOUNTS 

established.  The  attempt  has  sometimes  been  made  to  limit 
by  law  for  incorporated  banks  the  proportion  of  transactions 
for  a  given  amount  of  capital,  but  no  such  provision  has  any 
foundation  except  a  conjectured  average,  too  rough  to  be  of 
service  in  any  individual  case.  In  this  respect,  as  in  so  many 
others,  the  judgment  of  the  persons  most  interested,  acting 
under  the  law  of  self-preservation,  is  far  more  trustworthy 
than  any  legislative  decision. 

The  capital  thus  to  be  provided  at  the  outset  is,  of  course,  in 
the  case  of  a  private  bank,  the  contribution  of  the  partners,  as 
in  any  other  undertaking.  In  the  case  of  an  incorporated  bank 
the  capital  is  divided  by  law  into  equal  shares  or  units  of  fixed 
amount;  as  e.  g.,  under  the  law  of  the  United  States,  a  capital 
of  $100,000  is  divided  into  1 ,000  shares  of  $100  each ;  and  these 
shares  are  contributed  by  the  individual  shareholders,  in  such 
proportion  as  they  please.  The  law  may  as  a  matter  of  public 
policy  limit  the  proportion  of  capital  stock  to  be  owned  by  any 
one  individual  or  firm,  and  it  may  also  limit  the  liability  of 
shareholders  for  debts  due  by  the  bank,  in  case  of  its  failure ; 
but  in  general,  in  the  absence  of  special  provisions  to  the  con- 
trary, the  powers,  rights,  and  liabilities  of  every  shareholder 
are  now  usually  determined  by  the  number  of  shares  of  the 
stock  contributed  or  owned  by  him.  In  the  election  of  direc- 
tors and  of  other  officers  for  the  immediate  management  of 
the  business,  every  share  entitles  its  owner  to  cast  one  vote; 
the  dividend  of  profit  is  divided  in  the  ratio  of  shares  owned, 
and  contributions  to  meet  losses,  if  required  by  law,  are  called 
for  in  the  same  ratio. 

The  capital  subscribed  by  the  intending  shareholders  must 
necessarily  be  paid  in  in  money  or  in  the  legal  tender  of  the 
country.  It  is  not  necessary  that  the  whole  should  be  paid  in 
at  the  outset,  but  the  payment  of  the  whole  usually  precedes 
the  full  establishment  of  the  business;  and,  in  the  case  of  in- 
corporated banks,  the  law  often  requires  that  some  definite 
proportion,  as  e.  $.,  one-half,  shall  be  paid  in  before  the  open- 
ing of  business,  in  order  to  insure  good  faith  and  a  solid  basis 
for  the  business  undertaken. 

If,  now,  we  undertake  to  represent  by  a  brief  statement  of 
account  the  condition  of  a  bank  having  a  capital  of  $100,000 


CAPITAL  A  LIABILITY  123 

paid  in,  in  specie,  on  the  morning  when  it  opens  its  doors  for 
business,  we  shall  have  the  following: 

Liabilities                                                 Resources 
Capital     $100,000      Specie    $100,000 

It  may  at  first  sight  appear  to  be  a  contradiction  in  terms, 
that  the  capital  should  be  set  down  as  a  liability  and  not  as  a 
resource.  But  we  must  here  distinguish  between  the  financial 
liability  for  what  has  been  received  from  the  shareholders  and 
the  right  of  property  in  the  thing  received.  The  bank  has  be- 
come accountable  to  its  shareholders  for  the  amounts  paid  in 
by  them  respectively,  but  the  money  actually  paid  in  has  be- 
come the  property  of  the  bank;  or,  in  the  language  of  ac- 
countants, the  bank  has  become  liable  for  its  capital,  and  the 
money  in  hand  is  for  the  present  its  resource  for  meeting  this 
liability,  or  for  explaining  the  disposition  made  of  what  has 
been  received. 

As  the  bank  requires  banking-rooms  and  a  certain  supply  of 
furniture  and  fixtures  for  the  convenient  transaction  of  its 
business,  we  may  suppose  it  to  expend  $5,000  of  its  cash  in 
providing  this  "  plant."  The  property  thus  procured,  with  the 
remaining  $95,000  in  cash,  will  then  be  the  aggregate  re- 
sources by  means  of  which  the  capital  is  to  be  accounted  for, 
and  the  account  will  stand  as  follows : 

Liabilities                                                 Resources 
Capital    $100,000     Real   estate,    furniture,   fix- 
tures, etc $  5,000 

Specie   95,ooo 


$100,000  $100,000 

The  bank,  however,  cannot  answer  the  purposes  of  its 
existence,  or  earn  a  profit  for  its  shareholders,  until  its  idle 
cash  is  converted  into  some  kind  of  interest-bearing  security. 
Nor  is  it  enough  that  a  permanent  investment  of  the  ordinary 
kind  should  be  made,  as  by  the  simple  exchange  of  the  cash 
for  government  bonds  or  railway  securities.  It  is  the  chief 
business  of  the  bank  to  afford  to  purchasers  and  dealers  the 
means  of  using,  by  anticipation,  funds  which  are  receivable  by 
them  in  the  future,  and  this  implies  both  the  purchase  of 
private  securities  or  "  business  paper  "  to  a  considerable  ex- 


124  BANKING  OPERATIONS  AND  ACCOUNTS 

tent,  and  also  frequent  change  and  renewal  of  purchases. 
Moreover,  while  the  private  capitalist  finds  it  advantageous  to 
make  simple  investments  of  a  permanent  sort,  this  would 
plainly  be  insufficient  for  the  shareholders  of  a  bank,  who  have 
to  pay  from  its  profits  some  serious  expenses  of  management, 
and  need,  therefore,  a  larger  field  for  earnings  than  the  or- 
dinary returns  on  their  capital  alone.  The  bank  being  obliged 
then  to  extend  its  operations  beyond  the  amount  of  its  capital, 
is  compelled  for  this  purpose  to  make  use  of  its  credit.  In 
fact,  it  is  only  by  such  a  use  of  its  credit  that  the  establishment 
becomes  in  reality  a  bank. 

Most  of  the  conditions  of  the  case  are  best  answered  by  the 
"  discount "  of  commercial  paper  as  above  described.  The 
time  for  which  such  obligations  have  to  run  varies  with  the 
custom  of  the  trade  which  gives  rise  to  them,  .but  is  in  most 
cases  short  enough  to  imply  early  repayment  to  the  bank. 
And  even  where  custom  gives  the  paper  longer  time,  if  the 
paper  itself  is  used  only  as  a  collateral  security,  the  note  which 
is  the  actual  object  of  negotiation  with  the  bank  is  by  prefer- 
ence usually  made  not  to  exceed  four  months.  It  is  easy  then 
to  arrange  the  purchases  of  paper  with  reference  to  the  times 
of  maturity,  so  as  to  provide  for  a  steady  succession  of  pay- 
ments to  the  bank,  and  thus  facilitate  the  reduction  of  the 
business,  if  necessary,  or  its  direction  into  new  channels,  as 
prudence  or  good  policy  may  require.  The  certainty  of 
prompt  payment  at  maturity,  needed  for  this  end,  is  presented 
in  a  high  degree  by  the  paper  created  in  the  ordinary  course  of 
business.  Independently  of  the  collateral  security  which  the 
bank  may  hold,  the  written  promise  of  a  merchant  or  manu- 
facturer to  pay  on  a  fixed  day  is  an  engagement  which  involves 
the  credit  of  the  promisor  so  far  that  failure  is  an  act  both  of 
legal  insolvency  and  of  commercial  dishonor.  Selected  with 
judgment,  then,  such  paper  is  not  only  the  investment  which 
most  completely  answers  the  purposes  of  the  bank's  existence, 
but  is  probably  as  safe  as  any  investment  which  could  be  found. 

It  may  easily  happen,  however,  that  the  bank  may  find  it 
desirable  to  invest  a  part  of  its  resources  in  some  other  form, 
either  because  good  commercial  paper  cannot  be  procured  in 
sufficient  amount,  or  as  a  matter  of  policy.  In  this  case  it  will 


BANK  LOANS  125 

purchase  such  other  securities  as  offer  not  only  complete  safety 
of  investment,  but  the  possibility  of  easy  conversion  into  cash 
in  case  of  need.  In  this  country  United  States  bonds,  and 
many  descriptions  of  State,  municipal,  and  corporation  bonds 
might  answer  this  purpose.  Stocks  would  more  rarely  answer 
it,  being  more  liable  to  the  fluctuations  in  price  caused  by  mis- 
fortune or  the  ordinary  vicissitudes  of  business.  Mortgages 
on  real  estate,  however,  would  not  be  admissible,  except  when 
held  as  a  security,  collateral  to  some  other  which  is  more  easily 
convertible,  for  even  when  the  mortgaged  property  is  so  ample 
and  stable  as  to  insure  the  goodness  of  the  mortgage,  the  con- 
version of  the  mortgage  into  cash  by  sale  is  not  always  easy, 
and  is  especially  difficult  at  those  times  when  the  bank  most 
needs  to  have  all  its  resources  at  command.  Indeed,  the  dan- 
ger to  be  apprehended  from  the  locking  up  of  resources,  in 
securities  which  may  be  solid  but  are  not  easily  realized,  is  so 
great,  that  it  has  been  said  to  be  the  first  duty  of  the  banker 
to  learn  to  distinguish  between  a  note  and  a  mortgage,  his  busi- 
ness lying  with  the  former.  Real  estate,  of  course,  cannot  be 
regarded  as  a  banking  security,  however  desirable  it  may  be 
as  an  investment  for  individuals,  for  it  is  not  only  subject  to 
great  fluctuations  in  value,  but  is  at  times  unsaleable.  .  .  . 

The  results  of  the  process  of  investment  in  commercial  paper 
and  in  other  securities  are  best  understood  when  we  trace  the 
effect  in  the  account  of  the  bank.  Taking  then  the  account  as 
it  stood  after  the  purchase  of  fixtures,  let  us  suppose  that  the 
bank  buys  paper  or  securities  from  those  dealing  with  it,  or,  in 
the  common  phrase,  makes  "  loans  to  its  customers,"  to  the 
amount  of  $90,000,  the  paper  being  in  many  pieces  and  having 
various  lengths  of  time  to  run,  but  averaging  about  three 
months.  Supposing  the  interest  to  be  computed  at  6  per 
cent.,  we  should  have  the  account  changed  by  the  operation  as. 
follows : 

Liabilities  Resources 

Capital    $100,000      Loans    $90,000 

Undivided  profits   1,35°      Real    estate,    furniture,    fix- 
Deposits  88,650         tu res,  etc 5,000 

Specie  95,ooo 

$190,000  $190,000 


126  BANKING  OPERATIONS  AND  ACCOUNTS 

Here  we  have  the  securities  which  certify  the  right  of  then 
bank  to  demand  and  receive  $90,000  at  a  future  date  placed 
among  the  resources;  the  net  proceeds  of  the  securities,  or  the 
aggregate  of  the  sums  which  the  bank  holds  itself  liable  to  pay 
for  them  on  demand,  stand  among  the  liabilities  as  deposits; 
and  the  interest  deducted  in  advance,  or  the  profit  on  the  opera- 
tion, which  the  bank  must  at  the  proper  time  account  for  to 
the  stockholders,  also  stands  as  a  liability.  This,  however,  is 
the  condition  of  the  account  at  the  moment  of  making  the 
investment,  when  the  bank  has  made  its  purchase  of  securities 
by  merely  creating  a  liability.  As  this  liability  is  real  and  must 
be  met,  so  far  as  the  depositors  at  any  time  see  fit  to  press 
it,  let  us  suppose  that  depositors  call  for  cash  to  the  amount 
of  $15,000,  and  we  shall  have  a  further  change  in  the  account 
as  follows: 

Liabilities  Resources 

Capital    $100,000     Loans    $90,000 

Undivided   profits i,35°      Real  estate,  etc 5,ooo 

Deposits  73,650      Specie   80,000 


$175,000  $175,000 

It  is  clear  that,  unless  the  enforcement  of  the  liability  for 
deposits  and  consequent  withdrawal  of  specie  goes  much 
farther  than  this,  the  bank  can  safely  increase  its  loans  or  its 
purchase  of  securities,  although  its  method  of  doing  so  is  by 
the  increase  of  its  liabilities.  We  will  suppose  it,  therefore, 
to  have  expanded  its  affairs  until  it  has  reached  something  like 
the  average  condition  of  those  banks  in  the  United  States, 
which,  being  incorporated  under  the  laws  of  the  several 
States,  are  not  authorized  to  issue  notes.  It  will  then  stand 
thus : 

Liabilities  Resources 

Capital    $100,000     Loans    $305,000 

Surplus 29,000      Bonds  and  stocks 23,000 

Undivided  profits   10,000      Real  estate   15,900 

Deposits  305,000     Other  assets  20,000 

Expenses   1,000 

Legal-tender  notes  1 

Cash  items. >-  80,000 

Specie  J 

$444,000  $444,000 


LIMIT  OF  LOAN  EXPANSION  127 

Postponing  for  the  present  the  consideration  of  some  terms 
which  here  occur  for  the  first  time,  it  appears  from  the  above 
account  that  purchases  of  securities  have  been  made  to  more 
than  three  times  the  amount  of  the  capital,  and  that  this  has 
been  effected  chiefly  by  the  creation  of  liabilities  in  the  form  of 
deposits.  What  determines  the  limit  to  which  this  process 
can  be  carried  ? 

If  depositors  seldom  demanded  the  payment  to  which  they 
are  entitled,  but  were  contented  with  the  mere  transfer  of  their 
rights  among  themselves  as  a  conventional  currency,  the  bank 
might  dispense  with  holding  any  large  amount  of  specie  or 
cash  in  any  form  and  keep  most  of  its  resources  employed  in 
its  productive  securities.  The  expansion  of  the  deposits  would 
then  resemble  in  its  effects  the  expansion  of  any  other  currency 
and  might  go  on  until  a  check  should  be  interposed  by  the 
consequent  rise  of  prices  and  demand  for  specie  for  exporta- 
tion. And  it  is  true,  as  we  shall  see,  that  in  communities 
where  banking  is  largely  practised,  the  use  of  deposits  as  cur- 
rency by  transfer  from  hand  to  hand  is  so  extensive,  that  a 
bank  in  good  credit  can  rely  upon  their  being  withdrawn  so 
slowly,  or  rather  to  so  small  an  extent,  as  to  make  it  unneces- 
sary to  have  cash  in  readiness  for  the  payment  of  more  than  a 
small  proportion  at  any  given  moment.  But  in  a  period  of 
financial  disorder  or  alarm,  withdrawals  may  be  made  earlier 
or  more  frequently,  and  a  larger  provision  of  cash  may  be 
needed  for  safety,  than  at  other  times;  the  kind  of  business 
carried  on  by  depositors  may  expose  one  bank,  or  the  banks 
in  one  place,  to  heavier  occasional  demands,  or  may  on  the 
other  hand  make  demands  steadier,  than  is  the  case  elsewhere ; 
and  a  city  bank  may  be  more  subject  to  heavy  calls  from  de- 
positors than  a  country  bank.  In  general,  then,  for  every 
bank,  in  its  place  and  under  the  circumstances  of  the  time, 
there  is  some  line  below  which  its  provision  of  cash  cannot 
safely  fall.  This  provision  of  cash,  which  in  the  account  last 
given  includes  the  cash  items,  specie,  and  legal-tender  notes,  is 
called  the  reserve,  and  the  necessity  of  maintaining  a  certain 
minimum  reserve  fixes  a  limit  to  the  ability  of  the  bank  to 
increase  its  securities.  For  obviously  any  increase  of  securi- 
ties, that  is,  of  loans  or  bonds,  must  ordinarily  be  effected, 


128  BANKING  OPERATIONS  AND  ACCOUNTS 

either  by  an  increase  of  deposits,  or  by  an  actual  expenditure 
of  cash.  If,  then,  the  reserve  were  already  as  low  as 
prudence  would  allow,  or  were  threatened  by  approaching 
heavy  demands  from  depositors,  no  increase  of  securities  could 
be  made  without  serious  .risk. 

What  proportion  the  reserve  should  bear  to  the  liabilities 
which  it  is  to  protect  is  a  question  which  the  law  has  some- 
times attempted  to  settle,  by  requiring  a  certain  minimum, 
leaving  it  to  every  individual  bank  to  determine  for  itself  how 
much  may  be  required  in  addition  to  this  minimum.  And 
this  is  no  doubt  as  far  as  any  general  rule  can  go.  As  has 
already  been  suggested,  the  requirements  for  safety  of  differ- 
ent banks  and  in  different  places  must  vary,  and  so  must  the 
requirements  of  the  same  bank  at  different  times.  In  fact, 
the  question  as  to  the  proper  amount  of  reserve  never  de- 
pends simply  on  the  absolute  ratio  of  the  reserve  to  the 
liabilities,  but  always  involves  further  questions  as  to  the 
probable  receipts  of  cash  by  the  bank  and  probable  demands 
upon  it,  in  the  near  future.  It  can  only  be  said  that  the  re- 
serve should  be  large  enough,  not  only  to  insure  the  immediate 
payment  of  any  probable  demand  from  depositors,  but  also  to 
secure  the  bank  from  being  brought  down  to  the  "  danger  line  " 
by  any  such  demand.  If  25  per  cent,  is  the  minimum  con- 
sistent with  safety,  the  reserve  should  be  far  enough  above 
this  to  be  secure  from  reduction  to  a  point  where  any  further 
demand  or  accident  may  make  the  situation  hazardous. 

In  the  management  of  its  reserve  the  bank  itself  necessarily 
feels  a  strong  conflict  of  interests.  On  the  one  hand,  it  is 
impelled  to  increase  its  securities  as  far  as  possible,  for  it  is 
from  them  that  it  derives  its  profits,  and  the  retention  of  a 
large  amount  of  idle  cash  is  felt  as  a  loss.  On  the  other  hand, 
the  maintenance  of  a  reserve  sufficient,  not  only  to  enable  the 
bank  to  continue  its  payments  but  to  inspire  the  public  with 
confidence  in  its  ability  to  continue  them,  is  a  necessity  of  its 
existence,  even  though  a  part  of  its  resources  do  thus  appear 
to  be  kept  permanently  idle.  As  a  natural  consequence,  the 
actual  settlement  of  the  question  in  favor  of  a  large  or  of  a 
small  reserve  in  any  particular  case  will  depend  in  good  meas- 


SECONDARY  RESERVE  1 29 

ure  on  the  temperament  of  the  managers.  In  every  banking 
community  may  be  found  "  conservative  "  banks,  the  caution 
of  whose  managers  forbids  them  to  take  risks  by  extending 
their  business  at  the  expense  of  an  ample  reserve ;  and  by  their 
side  may  be  seen  the  more  "  active  "  banks,  whose  managers 
habitually  spread  all  possible  sail,  and  provide  for  the  storm 
only  when  it  comes. 

It  is  to  be  observed  that  the  necessity  of  providing  a  cash 
reserve  is  not  met  by  the  excellence  of  the  securities  held  by 
the  bank.  Although  their  certainty  of  payment  at  maturity 
be  absolute,  still  the  demands  upon  the  banks  are  demands  for 
cash,  and  cannot  be  answered  by  the  offer  of  even  the  best 
securities.  If  the  depositor  or  creditor  does  not  receive  cash 
in  full  for  his  demand  when  it  is  made,  the  bank  has  failed, 
and  any  satisfaction  of  his  claim  by  the  delivery  of  a  security 
is,  as  it  were,  only  the  beginning  of  a  division  of  the  property 
of  the  bank  among  its  creditors.  Specie,  therefore,  or  the 
paper  which  is  a  substitute  for  it  as  a  legal  tender  for  debt, 
forms  the  real  banking  reserve.  The  reserve  of  the  bank 
may,  however,  be  greatly  strengthened  by  the  judicious  selec- 
tion of  securities.  For  example,  if,  in  the  account  above 
given,  the  "  bonds  and  stocks  "  are,  as  they  should  be,  of  de- 
scriptions which  are  readily  saleable,  they  afford  the  means  of 
replenishing  the  reserve  in  case  of  need,  without  foregoing 
the  enjoyment  of  an  income  from  this  amount  of  resources 
for  the  present.  In  extreme  cases  of  general  financial  panic, 
it  is  true,  even  the  strongest  government  securities  may  find 
but  few  purchasers;  still  such  a  provision  is  the  best  support 
which  can  be  had  in  the  absence  of,  or  as  an  auxiliary  to,  a 
sufficient  reserve  of  actual  cash. 

The  natural  method  of  securing  the  proper  apportionment 
of  resources  between  securities  and  reserve,  under  ordinary 
circumstances,  is  by  increasing  or  diminishing  the  loans,  or, 
in  other  words,  the  purchases  of  securities  made  from  day  to 
day  in  the  regular  course  of  business.  That  part  of  the 
securities  which  consists  of  the  promises  of  individuals  or 
firms  to  pay  to  the  bank  at  fixed  dates,  is  made  up  of  many 
such  pieces  of  commercial  paper,  maturing,  if  properly  mar- 


130  BANKING  OPERATIONS  AND  ACCOUNTS 

shalled,  in  tolerably  steady  succession.  The  payment  of  one 
of  these  engagements  when  it  becomes  due  may  be  made  either 
in  money,  or  by  the  surrender  to  the  bank  of  an  equal  amount 
of  its  own  liabilities  ...  [in  the  form  of  deposits].  In 
the  former  case,  the  payment  of  the  maturing  paper  to  the  bank 
is  in  fact  the  conversion  of  a  security  into  cash,  and  increases 
the  reserve  without  change  in  the  liabilities;  in  the  latter,  the 
reduction  of  securities  is  balanced  by  a  reduction  of  liabilities 
which  raises  the  proportion  of  reserve.  If,  then,  the  bank 
stops  its  "  discounts  "  or  the  investments  in  new  securities, 
or  if  it  even  slackens  its  usual  activity  in  making  such  invest- 
ments, the  regular  succession  of  maturing  paper  will  gradually 
strengthen  its  reserve;  if  it  increases  its  activity  in  investment, 
it  will  weaken  or  lower  its  reserve ;  and  if  it  adjusts  the  amount 
of  its  new  investments  to  the  regular  stream  of  payments  made 
by  its  debtors,  it  may  keep  the  strength  of  its  reserve  unaltered, 
until  some  change  in  the  condition  of  affairs  brings  cash  to  it 
or  takes  cash  away  by  some  other  process. 

This  natural  dependence  of  the  reserve  upon  the  more  or 
less  rapid  re-investment  of  its  resources  by  the  bank  is  dis- 
tinctly recognized  by  the  law. of  the  United  States,  which  pro- 
vides that  when  the  reserve  of  any  national  bank  falls  below 
the  legal  minimum,  such  bank  "  shall  not  increase  its  liabilities 
by  making  any  new  loans  or  discounts,"  until  its  reserve  has 
been  restored  to  its  required  proportion.  By  a  less  harsh 
application  of  the  same  principle,  the  Bank  of  England  operates 
upon  its  reserve  by  lowering  or  raising  its  rate  of  discount, 
and  thus  encouraging  or  discouraging  applications  for  loans. 
And  it  was  with  a  view  of  facilitating  the  replenishment  of  the 
reserve  by  the  curtailment  of  loans,  that  the  law  of  Louisiana 
formerly  provided  that  the  banks  of  New  Orleans  should  hold 
what  were  called  "  short  bills,"  or  paper  maturing  within 
ninety  days,  to  the  amount  of  two-thirds  of  their  cash  liabili- 
ties, so  that  the  constant  stream  of  payments  of  such  paper 
might  always  insure  to  every  bank  the  early  command  of  a 
large  part  of  its  resources. 

To  return,  in  conclusion,  to  the  account  last  given ;  we  have 
there  among  the  liabilities  certain  Sums  classified  as  "  surplus  " 


HEADS  OF  ACCOUNTS  131 

and  as  "  undivided  profits."  Taken  together  these  sums  rep- 
resent the  profits  which  have  been  made,  but  not  divided  among 
the  stockholders,  and  which  are  therefore  to  be  accounted  for 
by  the  bank.  The  surplus  is  that  portion  of  these  profits  which 
as  a  matter  of  policy  it  has  been  determined  not  to  divide  and 
pay  over  to  the  stockholders,  but  to  retain  in  the  business,  as 
in  fact,  although  not  in  name,  an  addition  to  the  capital.  The 
remaining  portion,  the  undivided  profits,  is  the  fund  from 
which,  after  payment  of  current  expenses  and  of  any  losses 
which  may  occur,  the  next  dividend  to  the  stockholders  will  be 
made.  The  current  expenses  are  for  the  present  entered  on  the 
other  side  of  the  account,  as  they  represent  a  certain  amount 
of  cash  which  has  disappeared ;  but  at  the  periodical  settlement 
of  accounts  they  must  be  deducted  from  the  undivided  profits, 
and  will  thus  drop  out  from  the  statement.  "  Other  assets," 
here  set  down  as  an  investment,  may  be  supposed  to  cover  any 
form  of  property  held  by  the  bank  and  not  otherwise  classified, 
but  especially  the  doubtful  securities,  or  such  property,  not 
properly  dealt  in  by  a  bank,  as  it  may  have  been  necessary  to 
take  and  to  hold  temporarily,  for  the  purpose  of  securing  some 
debt  not  otherwise  recoverable.  For  example,  although  the 
bank  could  not  properly  invest  in  a  mortgage,  it  might  be  wise 
for  it  to  accept  a  mortgage  in  settlement  with  an  embarrassed 
debtor,  and  in  this  case  the  mortgage  would  stand  among  the 
"  other  assets."  And,  finally,  "  cash  items  "  include  such  de- 
mands on  individuals  or  other  banks  as  are  collectible  in  cash 
and  can  therefore  fairly  be  deemed  the  equivalent  of  cash  in 
hand.  In  the  absence  of  any  legal  provision  limiting  the 
classification  of  such  demands  as  reserve,  they  may  be  regarded 
as  virtually  a  part  of  the  reserve,  which  in  the  case  before  us 
may  therefore  be  treated  as  made  up  of  cash  items,  specie,  and 
legal-tender  notes. 

To  illustrate  what  has  been  said  in  this  chapter  we  will  now 
suppose  the  bank  to  make  the  following  operations : 

a.  To  add  to  its  securities  $20,000,  by  discount  of  three- 
months  paper  at  6  per  cent.,  three-fourths  being  purchased  by 
the  creation  of  liabilities,  and  one-fourth  by  the  expenditure  of 
cash.  The  account  would  then  stand  as  follows : 


132 


BANKING  OPERATIONS  AND  ACCOUNTS 


Liabilities 

Capital    $100,000 

Surplus 29,000 

Undivided  profits   10,300 

Deposits  319,775 


Resources 

Loans    $325,000 

Bonds  and  stocks  23,000 

Real  estate   15,000 

Other   assets    20,000 

Expenses   1,000 

Reserve    75,075 


$459,075 


$459,075 


b.  To  retrace  its  steps  by  diminishing  its  "  discounts  "  or 
holding  of  securities  to  the  extent  of  $50,000,  of  which  four- 
fifths  are  paid  to  it  by  the  surrender  of  demands  for  deposits 
to  a  like  amount  and  one-fifth  in  cash;  to  pay  $1,250  for  cur- 
rent expenses;  and  further  to  increase  its  reserve  by  the  sale 
of  bonds  and  stocks  to  the  amount  of  $10,000.  The  following 
would  then  be  the  state  of  the  account : 


Liabilities 

Capital    $100,000 

Surplus    29,000 

Undivided  profits   10,300 

Deposits    279,775 


Resources 

Loans   $275,000 

Bonds  and  stocks  13,000 

Real  estate   15,000 

Other  assets  20,000 

Expenses    2,250 

Reserve    93,825 


$419,075 


$419,075 


c.  To  sell  $2,000  of  its  other  assets  for  cash  with  a  loss  of 
$500;  to  make  a  semi-annual  dividend  of  4  per  cent.,  of  which 
one-half  is  credited  to  stockholders  who  happen  to  be  deposit- 
ors also,  and  one-half  is  paid  in  cash;  to  sell  $4,000  of  bonds 
at  a  profit  of  15  per  cent.,  and  to  carry  $1,000  of  its  undivided 
profits  to  surplus.  The  account  would  then  stand  at  the  be- 
ginning of  the  new  half  year,  as  follows : 


Liabilities 

Capital    $100,000 

Surplus     30,000 

Undivided  profits   3,150 

Deposits  281,775 


$414,925 


Resources 

Loans    $275,000 

Bonds  and  stocks  9,000 

Real  estate  15,000 

Other  assets  18.000 

Reserve    97,925 

$414,925 


A  BANK  STATEMENT 


133 


STATEMENT  OF  A  REPRESENTATIVE  NATIONAL  BANK 


Resources 

Loans  and  discounts  .  ..  .$739,743.27 

Overdrafts,  secured    ....         973-o8 

U.  S.  bonds  deposited  to 
secure  circulation  ....  100,000.00 

U.  S.  bonds  pledged  to 
secure  U.  S.  deposits.  .  1,000.00 

Bonds  other  than  U.  S. 
bonds  pledged  to  secure 
postal  savings  deposits  7,000.00 

Other  Securities 191,098.05 

Stock  of  Federal  Reserve 
bank  4,800.00 

Banking  House 30,000.00 

Furniture  and  Fixtures. .       5,000.00 

Due  from  Federal  Re- 
serve Bank 20,000.00 

Due  from  approved  re- 
serve agents  89,919.25 

Due  from  other  banks. .     12,074.23 

Checks  on  banks  in  same 
city  6,051.46 

Outside  checks  and  other 
cash  items  13,171.83 

Fractional  currency,  nick- 
els, and  cents  283.14 

Notes  of  other  national 
banks  1,295.00 

Coin  and  certificates  ....     38,604.05 

Legal-tender  notes    25,000.00 

Redemption  fund 3,500.00 


Liabilities 

Capital      stock 

paid   in    ....  $100,000.00 

Surplus  fund. .  60,000.00 

Undivided 
profits    40,877.46 

Less  current 
expenses,  in- 
terest, and 
taxes  paid.  .17,110.28  23,767.18 

Circulating 
Notes      Out- 
standing   . . .  98,500.00 

Individual  de- 
posits sub- 
ject to  check  404,871.37 

Certificates  of 
deposit  due 
in  less  than 
30  days 596,335.82 

Certified 
Checks     125.00 

United  States 
deposits 1,000.00 

Postal  savings 
deposits 4,9i3-99 


$1,289,513.36  $1,289,513.36 

1  The  Method  and  Extent  of  Credit  Issue. —  Assume 
that  a  bank  with  a  cash  capital  of  $100,000  is  opening  for 
business  in  an  isolated  town  and  is  the  only  bank  in  that  town. 
How  much  can  it  lend  ?  Ordinarily  a  bank  lends  by  discount- 
ing a  custorher's  note  and  by  giving  the  customer  a  deposit 
credit  upon  its  books  for  the  proceeds  of  the  note.  .  .  .  If, 
now,  our  bank  in  question  lends  $100,000,  giving  deposit  credit 
for  this  sum,  it  has  $100,000  of  cash  on  hand  against  $100,000 
of  cash  liability.  Its  statement  will  stand  as  follows: 

Liabilities 

Capital    Stock    $100,000 

Deposits     100,000 


Resources 

Cash    $100,000 

Notes    100,000 


$200,000  $200,000 

Now  let  it  lend  another  $100,000.     With  its  loans  and  de- 
posits each  standing  at  $200,000  its  reserves  are  50  per  cent. 

1  Herbert  Joseph  Davenport,   The  Economics  of  Enterprise,  pp.  260-6. 
The   Macmillan   Company.     New   York.     1913. 


134  BANKING  OPERATIONS  AND  ACCOUNTS 

of  its  demand  liability.     Only  with  $666,666  of  loans  will  its 
reserves  have  reached  .  .  .   [a]  1  5  per  cent,  limit  : 

Resources  Liabilities 

Cash    .....................  $100,000  Capital   Stock    ............  $100,000 

Notes     (Loans     and     Dis-  Deposits  ..................  666,666 

counts)     ................  666,666 

$766,666  $766,666 

Further:  Suppose  that  $100,000  of  cash  is  deposited  with 
the  bank  from  the  channels  of  business  ;  how  much  more  can 
it  lend?  Fifteen  thousand  dollars  must  be  retained  as  reserve 
against  the  new  liability;  $85,000  is  available  as  reserves 
against  further  lending.  Based  upon  these  further  reserves 
loans  may  be  granted  to  the  extent  of  nearly  $600,000  more. 
In  fact,  only  with  an  expansion  of  $1,233.333  m  loans  and 
in  derived  deposits  —  a  total  deposit  of  $1,335,333  —  nas  its 
reserve  fallen  to  the  ratio  of  15  per  cent,  of  its  liability. 

Resources  Liabilities 

Cash  (original)  ...........  $100,000     Capital   Stock    ............  $100,000 

Loans  and  Discounts   .....  666,666     Deposits  ..................  666,666 

C-h  <*w)  ...............  «5£S     Deposits  (new) 

L  &  D  (new)  .............  566,666 


$1,433,333  $1,433,333 

The  situation  summarizes  as  follows  :  On  its  asset  side  the 
bank  has  $200,000  of  cash  and  $1,233,333  °f  securities  (Bills 
and  Notes).  Its  deposit  liabilities  amount  to  $1,333,333- 

2 
Its  cash  is  -  of  its  liability  —  15  per  cent. 

13-3  + 
The  Function  of  Reserves.  —  If  this  is  what  actual  bank- 

ing means,  is  banking  safe?  What  would  happen  if  all  these 
deposits  were  immediately  called  for  in  cash?  True,  not  all 
are  likely  to  be  called  for,  but  some  cash  will  be  demanded. 
In  fact,  the  borrowers,  instead  of  accepting  all  of  the  proceeds 
of  these  notes  in  deposit  credit,  will  in  some  measure  require 
and  receive  cash.  Precisely  so;  and  so  the  bank  must  keep 
on  hand  a  cash  reserve  to  meet  this  possibility.  For  the  most 
part,  however,  the  customers  of  the  bank  make  payments 
through  checks  upon  the  bank,  and  these  credits  are  deposited 


FUNCTION  OF  RESERVES  135 

in  turn  to  the  credit  of  other  customers.  No  cash,  but  only 
bookkeeping,  is  required.  And  if  some  customers  draw  out 
cash,  other  customers  will  probably  receive  it  and  return  it  to 
the  bank.  A  reserve  of  15  per  cent,  is  enough  for  the  case. 
There  would,  indeed,  be  small  gain  in  banking  if  against  every 
deposit  an  equal  sum  in  cash  must  be  held  in  store  by  the  bank. 

Economy  of  Redemption  Money.  —  It  is  thus  evident 
that  the  employment  of  $200.000  cash  as  a  banking  reserve  has 
made  possible  the  existence  of  a  more  than  sixfold  volume  of 
circulating  medium  —  currency.  Against  each  $1.000  of  de- 
posit liability  there  need  be  only  $150  of  actual  cash.  The 
bank  customer,  however,  thinks  of  his  deposit  claim  as  money, 
and  it  really  serves  him  all  the  purposes  of  money.  The  right 
to  have  the  money  when  desired  is  as  good  as  the  actual  money, 
is  more  convenient,  and  is  as  readily  and  as  serviceably  trans- 
ferred. 

The  economy  of  money  through  the  use  of  credit  substi- 
tutes for  money  extends  really  further  than  the  foregoing 
analysis  indicates.  Under  the  [now  superseded]  law,  three- 
fifths  of  the  reserves  of  a  rural  bank  may  be  on  deposit  with 
banks  in  reserve  cities.  Thus  against  $100.000  of  deposit 
liability  the  rural  bank  needs  hold  only  $6,000  of  reserve 
money.  Against  the  deposit  of  the  remaining  $9,000,  the  re- 
serve city  bank  is  required  .in  turn  to  hold  a  reserve  of  only 
25  per  cent.  —  $2,250.  And  of  this  required  $2,250,  one- 
half  may  be  represented  by  deposits  in  central  reserve  cities, 
e.  g.,  New  York,  Chicago,  and  St.  Louis.  Against  the  $1,125 
deposited  with  it  the  central  reserve  bank  is  required  to  hold 
only  25  per  cent,  of  reserves  —  $281.25.  Thus  at  the  outside 
limit  of  credit  extension,  $100,000  of  deposit  currency  may  be 
supported  by  only  $7,406.25  of  reserves  in  money, 


one  dollar  of  reserves  upholding  $13  of  currency.1 

It  is,  of  course,  not  true  that  the  banks  ordinarily  allow 
their  reserves  to  run  as  low  as  the  legal  limit,  or  make  the 
utmost  possible  use  of  the  privilege  of  counting  claims  against 

1  It  should  not  be  overlooked,  furthermore,  that  the.  velocity  of  the 
circulation  of  deposits  is  approximately  two  and  one-half  times  that  of 
money.  —  EDITOR. 


136  BANKING  OPERATIONS  AND  ACCOUNTS 

one  another  as  legal  reserves.  Nor  is  it  accurately  true  that 
all  forms  of  money  are  of  equal  efficiency  in  the  support  of 
credit.  Not  all  forms  of  money,  but  only  those  of  the  higher 
levels  in  the  money  scale,  are  allowed  to  be  counted  as  legal 
reserves.  .  .  .  Some  forms  of  money  make  demands  upon 
other  forms  for  redemption,  or  are  limited  in  exchange  power 
to  the  exchange  power  of  the  form  in  which  redemption  is  to 
be  made.  The  total  exchange  efficiency  of  the  money  of  a 
country  is,  then,  not  accurately  to  be  computed  on  the  assump- 
tion that  all  moneys  are  equally  efficient  for  all  purposes  — 
that  some  are  not  in  varying  degree,  burdens  upon  the  money 
functions  of  the  others. 

Banking  Viewed  in  Detail  and  in  the  Aggregate. —  And 
one  further  modification  is  called  for.  The  analysis  so  far 
made,  while  valid  for  any  isolated  bank,  or  for  the  banking 
system  regarded  as  an  aggregate,  is  not  precisely  accurate  for 
the  affairs  of  any  one  competing  bank  among  other  banks. 
When  the  check  drawn  by  the  borrowing  depositor  may  be 
deposited  in  other  banks  and  collected  by  them  against  the 
lending  bank,  its  granting  of  credits  rapidly  draws  down  its 
reserves  to  swell  the  reserves  of  its  competitors.  One  hun- 
dred thousand  dollars  of  new  reserves  may  not  mean  to  it  an 
increase  of  lending  power  of  more  than,  say,  $125,000.  For 
banks  in  the  aggregate,  however,  this  increase  of  reserves 
brings  its  full  several-fold  increase  of  lending  power,  provided 
that  all  the  reserve  efficiency  is  utilized  in  whatever  bank  it 
rests.  As  the  lending  by  each  bank  is  depleting  its  reserves, 
the  lending  which  other  banks  are  doing  is  reinforcing  these 
reserves.  The  aggregate  possible  extension  of  credit  is  not 
changed. 

What  Banks  Actually  Do  and  Lend. —  It  follows  from 
the  foregoing  analysis  that,  in  the  main,  banks  do.  not  lend  their 
deposits,  but  rather,  by  their  own  extensions  of  credit,  create 
the  deposits;  that  these  deposits  are  funds  which  the  deposit- 
creditors  of  the  bank  can  lend  if  they  will,  and  that  many  men 
into  whose  hands  these  deposits  fall  through  transfer  are 
certain  to  use  them  as  funds  to  be  lent.  In  fact,  also,  even 
when  the  deposits  in  the  bank  are  not  derived  from  the  lending 
activity  of  the  bank,  but  are  really  funds  deposited  from  out- 


BANKING  A  FORM  OF  SURETYSHIP  137 

side  sources,  these  funds  are  commonly  used  by  the  bank  as  a 
reserve  basis  on  which  loans  are  extended  rather  than  as  funds 
which  are  themselves  loaned  out  by  the  bank.  Banks  are,  in 
truth,  mostly  intermediaries  between  debtors  and  creditors  — 
but  not  in  the  sense  of  borrowing  funds  from  one  class  of 
customers  in  order  to  lend  them  to  another  class,  but  rather  in 
the  sense  of  creating  for  their  borrowing  customers  funds 
which  may  be  used  by  these  borrowers  as  present  purchasing 
power.  The  borrower  becomes  indebted  to  the  bank  in  order 
that  for  his  own  purposes  he  may  use  the  promise  of  the  bank 
as  the  equivalent  of  cash  to  himself.  In  the  form  of  a  deposit 
liability  the  bank  becomes  a  debtor  to  whomever  the  borrower 
shall  nominate.  The  fact  that  the  borrower  pays  interest 
while  the  bank  undertakes  a  noninterest-bearing  obligation,  or 
pays  relatively  low  interest,  explains  in  the  main  the  gains  at- 
tending the  business  of  commercial  banking. 

Deposits  and  Solvency. —  It  is,  therefore,  a  sheer  blun- 
der to  infer  that  a  bank  is  rich  or  strong  because  of  its  great 
total  of  deposits,  or  to  regard  deposits  in  banking  institutions 
as  making  part  of  the  aggregate  wealth  of  the  community. 
Instead,  the  deposits  indicate  for  a  bank  the  extent  of  its  oper- 
ations, and  indicate  for  a  community  the  extent  to  which  the 
banks,  under  the  guise  of  noninterest-bearing  obligations,  have 
assumed  the  debts  of  business  men,  on  terms  of  these  business 
men  becoming  debtors  —  and  interest-paying  debtors  —  to  the 
banks.  The  solvency  of  the  bank  is  in  its  portfolio  of  securi- 
ties. Its  deposits  are  not  its  assets,  but  its  liabilities.  These 
liabilities  it  has  mostly  created  for  the  use  of  its  borrowers. 
The  further  it  may  safely  go  in  assuming  liabilities,  the  larger 
its  holdings  of  borrowers'  notes  may  be,  and  the  more  interest 
or  discount  charges  it  may  collect.  Essentially,  therefore,  the 
business  of  a  bank  is  a  form  of  suretyship  —  the  guaranteeing 
of  its  borrowers'  solvency  —  an  underwriting  of  the  credit  of 
its  customers.  The  bank  transfers  its  customers'  prospective 
future  paying  power  into  present  funds.  It  is  for  this  reason 
that  the  contract  takes  the  form  of  a  money  loan  and  the 
premium  the  guise  of  an  interest  payment. 

Bank  Loans  Related  to  Currency  and  Loan  Funds. — 
And  note  now  that  it  is  precisely  because  the  business  of  a  bank 


138  BANKING  OPERATIONS  AND  ACCOUNTS 

is  to  furnish  to  its  borrower  a  present  purchasing  power  for 
his  own  use  that  the  business  of  banking  becomes  the  source 
of  the  larger  part  of  the  circulating  medium  of  society.  In 
their  service  to  their  customers  the  banks  create  currency ;  and 
in  creating  currency  they  create  loan  funds  which,  in  the  hands 
of  the  holders  of  them,  are  available  like  other  currency  for 
any  purpose,  either  lending  or  other. 

The  Sources  of  Currency  Supply. —  It  is,  then,  clear  that 
the  larger  part  of  the  circulating  medium  of  society  is  not 
money;  that  not  all  of  the  money  that  there  is  is  bullion 
money;  and  that  not  even  all  of  the  bullion  money  need  be 
ultimate  money  —  redemption  money  of  the  highest  rank. 
The  sources  of  currency  in  society  are  various  —  some  of  it 
bullion,  with  a  cost  of  production  limit  upon  its  supply,  some 
of  it  government  paper,  substantially  free  of-  cost,  some  of 
it  banking  credit  with  certain  peculiar  and  appropriate  costs 
attending  its  issue. 

Currency  and  Its  Cost  of  Production. —  It  is  obvious  that 
the  actual  limitations  upon  the  supply  of  exchange  media 
must  be  made  clear  if  we  are  to  understand  the  influences 
which  are  fundamental  to  the  exchange  values  of  the  currency 
unit.  Only,  indeed,  by  this  investigation  of  the  sources  of 
the  supply,  and  of  the  terms  on  which  each  different  factor  of 
the  supply  is  available,  are  we  in  position  to  understand  the 
influences  which  impose  upon  bidders  for  money  a  certain  level 
of  sacrifice  in  obtaining  it. 

What,  then,  are  the  limitations  upon  the  supply  of  credit 
currency  supplied  by  the  banks?  In  other  words,  what  are 
the  banking  costs  in  the  granting  of  demand  deposit  rights  to 
customers?  Evidently  limitations  there  must  be,  and  limita- 
tions in  the  nature  of  costs,  else  the  competitive  activity  of  the 
banks  would  indefinitely  increase  the  supply  of  currency,  and 
any  would-be  purchaser  of  goods  or  payor  of  debts  or  pro- 
jector of  an  enterprise  could  have  the  time  use  of  purchasing 
power  gratis;  no  limit  would  exist  to  the  rise  in  prices  which 
must  attend  this  increase  in  the  circulating  medium. 

What  are  these  limitations?  (i)  Each  bank  must  conform 
the  volume  of  its  lending,  and  therewith  its  issue  of  circulating 
credit,  to  the  fundamental  requirement  that  it  be  always  able 


PROTECTION  OF  RESERVES  139 

to  make  good  its  agreement  to  discharge  its  deposit  liabilities 
on  demand.  To  maintain  reserves  involves  expense.  Es- 
pecially may  it  be  expensive  if  they  have  been  allowed  to  get 
low ;  securities  may  have  to  be  marketed  at  a  sacrifice,  or  good 
customers  pressed  for  payment  at  inconvenient  times.  In 
periods  of  general  pressure  or  panic,  other  banks  are  not  likely 
to  be  in  a  position  to  lend  their  own  reserve  funds  or  to  con- 
sent to  create  deposit  credit  in  aid  of  still  other  suffering 
banks.  Not  rarely  the  Bank  of  England,  in  the  attempt  to 
attract  reserve  funds,  advances  bank  notes  or  deposit  credit  to 
importers  of  gold,  without  imposing  the  customary  interest 
charge  for  the  covering  of  the  delays  of  the  mint.  In  at  least 
one  case,  in  1890,  it  borrowed  reserves  from  the  Bank  of 
France.  In  1907  the  United  States  Treasury  made  especially 
large  money  deposits  with  the  national  banks  of  New  York 
to  help  eke  out  the  needed  reserves.  Meantime  the  interior 
banks  were  compelled  to  pay  to  exporting  merchants  generous 
premiums  for  exchange  bills  upon  Europe,  through  which, 
despite  the  high  interest  rates  ruling  in  European  markets, 
these  banks  were  able  to  import  107  millions  of  gold  for  their 
own  reserve  requirements.  In  fact,  the  banking  business  in- 
volves the  hazard  not  merely  that  some  of  the  debtors  of  the 
bank  may  become  insolvent,  but  also  the  general  and  overhead 
hazard  attaching  to  its  underwriting  service  that  it  may  itself 
in  time  of  stress  become  unable  to  meet  its  obligations.  Its 
liabilities  must  not  be  allowed  to  get  seriously  out  of  ratio  to 
its  cash  resources. 

The  Protection  of  Reserves. —  In  point  of  fact  also  the 
efforts  of  the  various  different  banks  to  maintain  each  its  own 
reserve  place  a  limit  on  the  extent  to  which  any  one  bank  can 
extend  its  activity  in  trie  expansion  of  loans  and  of  the  de- 
rivative liabilities.  Just  as  a  relatively  liberal  granting  of 
credit  by  one  bank  must  tend  to  transfer  its  reserves  to  other 
banks,  so'  a  relatively  great  extension  of  credit  in  one  center 
or  in  one  country  must  tend  to  transfer  the  reserves,  e.  g.,  gold, 
to  other  centers  or  countries.  Even  were  it  true  that  a  local 
credit  expansion  has  no  effect  upon  local  prices  and  thereby 
upon  the  currents  of  trade,  some  transfers  of  reserves  would 
still  take  place,  and  would  impose  a  policy  of  restriction  in 


140  BANKING  OPERATIONS  AND  ACCOUNTS 

credit  accommodations.  .  .  .  The  influence  is  actually  exerted 
by  both  methods. 

(2)  Another  Cost  in  Bank-Made  Currency. —  The  loan 
rates  of  the  bank  must  also  provide  a  fund  to  cover  its  costs 
of  administration  —  salaries,  clerk  hire,  rents,  and  the  like. 
Where  transactions  run  in  large  units  the  ratio  of  expense  to 
the  volume  of  business  may  be  low.  This  is  in  part  the  ex- 
planation for  the  low  rates  of  discount  in  the  great  financial 
centers  compared  with  the  rates  outside.  Credit  currency  has 
its  cost  of  production  rate  as  truly  as  any  other  service  upon 
the  market.  .  .  . 

THE  RELATION  BETWEEN  LOANS  AND  DEPOSITS 

1  The  money  of  modern  English  commerce  and  finance  is  the 
cheque,  and  the  credit  dealt  in  in  the  London  money  market  is 
the  right  to  draw  a  cheque.  .  .  . 

Now  that  we  have  come  to  the  point  at  which  the  manu- 
facture of  the  right  to  draw  cheques  has  to  be  made  as  clear 
as  may  be,  it  will  be  well  to  come  into  close  touch  with  the 
facts  of  the  case  and  look  at  a  bank  balance-sheet  of  to-day. 
In  order  to  get  a  fair  average  specimen  I  have  taken  the  latest 
available  balance-sheets  of  half  a  dozen  of  the  biggest  London 
banks,  and  put  their  figures  together.  .  .  .  Let  us  examine  the 
aggregated  specimen  that  I  have  drawn  up. 

Millions  Millions 

of  £  of  £ 

Capital  paid  up  16          Cash    in    hand    and    at    the 

Reserve  Fund    1 1  Bank  of  England 4.3 

Current     and     deposit     ac-  Loans    at    call    and    short 

counts  249  notice    27^/2 

Acceptance     on     behalf     of                    Bills     discounted     and     ad- 
customers    i654          vances 153 

Profit  and  Loss  account v/2      Investments    48 

Liability    of    customers    on 

acceptances   

Premises    6 


294  204 

The  above  statement  does  not  include  the  figures  of  the 
Bank  of  England,  but  is  an  agglomeration  of  the  balance-sheets 
of  six  of  the  biggest  of  the  ordinary  joint-stock  banks. 

1  Hartley  Withers,  The  Meaning  of  Money,  pp.  57-73.    E.  P.  Dutton  and 
Company.    New  York.    1914. 


RELATION  OF  LOANS  TO  DEPOSITS  14I 

The  first  feature  that  strikes  the  casual  observer  is  the  small- 
ness  of  the  paid-up  capital  of  the  banks  when  compared  with 
the  vastness  of  the  figures  that  they  handle.  We  see  that  only 
1 6  millions  out  of  the  294  that  they  have  to  account  for  have 
been  actually  paid  up  by  shareholders,  though  1 1  millions  have 
been  retained  out  of  past  profits  and  accumulated  in  reserve 
funds  ["  surplus,"  in  United  States],  and  il/2  millions  are  due 
to  shareholders,  for  distribution  as  dividend  or  addition  to 
reserve,  in  the  shape  of  the  profit  and  loss  account  balance  for 
the  period  covered  by  the  balance-sheet.  A  profit  of  il/2 
millions  on  16  is  handsome  enough,  especially  when  it  is  con- 
sidered that  most  of  these  balance-sheets  covered  a  half-year's 
work,  but  il/2  millions  out  of  294  is  a  trifle,  and  it  thus  appears 
that  a  narrow  margin  of  profit  on  their  total  turn-over  enables 
the  banks  to  pay  good  dividends,  and  that  the  business  of  credit 
manufacture  earns  its  reward,  as  might  be  expected,  out  of 
the  credit  that  it  makes. 

Proceeding  in  our  examination,  we  see  that  the  item  of 
acceptances  on  behalf  of  customers  on  one  side  is  balanced 
by  the  liability  of  customers  on  the  other.  This  means  that  the 
banks  have  accepted  bills  for  their  customers  (so  making  them 
first-class  paper  and  easily  negotiable),  and  are  so  technically 
liable  to  meet  them  on  maturity;  but  since  the  customers  are 
expected  to  meet  them,  and  have  presumably  given  due  security, 
this  liability  of  the  customer  to  the  bank  is  an  offsetting  asset 
against  the  acceptance.  And  since  the  acceptance  business  is  a 
comparatively  small  item,  and  a  bank's  liability  under  its  ac- 
ceptances is  not  a  liability  in  quite  the  same  sense  as  its  deposits, 
and  does  not  immediately  affect  the  present  question  of  the 
manufacture  of  currency,  it  may  be  omitted  for  the  present. 
We  can  thus  simplify  the  balance-sheet  by  taking  out  this 
contra  entry  on  both  sides. 

Further  analysis  of  the  liabilities  shows  that  the  capital, 
reserves,  or  surplus,  and  profit  and  loss  balance  may  be  re- 
garded as  due  from  the  banks  to  their  shareholders,  and  that 
the  remaining  big  item,  current  and  deposit  accounts,  is  due  to 
their  customers.  This  is  the  item  which  is  usually  spoken  of 
as  the  deposits,  according  to  the  tiresome  habit  of  monetary 
nomenclature  which  seems  to  delight  in  applying  the  same 


142  BANKING  OPERATIONS  AND  ACCOUNTS 

name  to  a  genus  and  one  of  the  species  into  which  it  is  divided. 
Just  as  the  bill  of  exchange  is  divided  into  cheques  and  bills 
of  exchange,  so  the  English  banks'  deposit  accounts  are  divided 
into  current  and  deposit  accounts.  But  most  people  who  have 
a  banking  account  know  the  meaning  of  this  distinction. 
Your  current  account  is  the  amount  at  your  credit  which  you 
can  draw  out,  or  against  which  you  can  draw  cheques,  at  any 
moment;  your  deposit  account  is  the  amount  that  you  have 
placed  on  deposit  with  the  bank  and  can  only  withdraw  on  a 
week's  or  longer  notice,  and  it  earns  a  rate  of  interest,  usually 
1 3/2  per  cent,  below  the  Bank  of  England's  official  rate.  The 
essential  point  to  be  grasped  is  the  fact  that  the  banks'  deposits, 
as  usually  spoken  of,  include  both  the  current  and  deposit  ac- 
counts, and  are  due  by  the  banks  to  their  customers. 

Now  let  us  see  how  this  huge  debt  from  the  banks  to  the 
public  has  been  created.  An  examination  of  the  assets  side 
of  the  balance-sheet  proves  that  most  of  it  has  been  created 
by  money  lent  to  their  customers  by  the  banks,  and  that  the 
cheque  currency  of  to-day  is,  like  the  note  currency  of  a  former 
day,  based  on  mutual  indebtedness  between  the  banks  and  their 
customers.  For  the  assets  side  shows  that  the  banks  hold  43 
millions  in  cash  and  at  the  Bank  of  England,  48  millions  in 
investments,  and  6  millions  invested  in  their  premises  —  the 
buildings  in  which  they  conduct  their  business  —  and  that 
iSol/2  millions  have  been  lent  by  them  to  their  customers,  either 
by  the  discounting  of  bills  or  by  advances  to  borrowers,  or  by 
loans  at  call  or  short  notice.  We  can  now  reconstruct  our 
balance-sheet,  leaving  out  the  acceptances  on  both  sides,  as 
follows : 

Millions  Millions 

of  £.  of  €. 

Due  to  shareholders 28^      Cash  in  hand  and  at  Bank 

Due  to  customers  249             of  England   43 

Investments    48 

Premises  6 

Due  from  customers 


2775/2  277^ 

And  it  thus  appears  that  nearly  three-quarters  of  the  amount 
due  from  the  banks  to  their  customers  are  due  from  their 
customers  to  the  banks,  having  been  borrowed  from  them  in 


RELATION  OF  LOANS  TO  DEPOSITS  143 

one  form  or  another.  And  this  proportion  would  perhaps  be 
exceeded  if  we  could  take  the  figures  of  English  banking  as  a 
whole.  But  that  cannot  be  done  at  present,  because  some  of 
the  smaller  banks  do  not  separate  their  cash  from  their  loans 
at  call  in  their  published  statements.  The  greater  part  of  the 
banks'  deposits  is  thus  seen  to  consist,  not  of  cash  paid  in,  but 
of  credits  borrowed.  For  every  loan  makes  a  deposit,  and 
since  our  balance-sheet  shows  180^2  millions  of  loans,  iSoJ/2 
out  of  the  249  millions  of  deposits  have  been  created  by  loans. 

To  show  how  a  loan  makes  a  deposit,  let  us  suppose  that  you 
want  to  buy  a  thousand-guinea  motor-car  and  raise  the  where- 
withal from  your  banker,  pledging  with  him  marketable  securi- 
ties, and  receiving  from  him  an  advance,  which  is  added  to 
your  current  account.  Being  a  prudent  person  you  make  this 
arrangement  several  days  before  you  have  to  pay  for  the  car, 
and  so  for  this  period  the  bank's  deposits  are  swollen  by  your 
£1,050,  and  on  the  other  side  of  its  balance-sheet  the  entry 
"  advances  to  customers  "  is  also  increased  by  this  amount,  and 
the  loan  has  clearly  created  a  deposit. 

But  you  raised  your  loan  for  a  definite  purpose,  and  not  to 
leave  with  your  bank,  and  it  might  be  thought  that  when  you 
use  it  to  pay  for  your  car  the  deposit  would  be  cancelled.  But 
not  so.  If  the  seller  of  your  car  banks  at  your  bank,  which 
we  will  suppose  to  be  Parr's,  he  will  pay  your  cheque  into  his 
own  account,  and  Parr's  bank's  position  with  regard  to  its 
deposits  will  be  unchanged,  still  showing  the  increase  due  to 
your  loan.  But  if,  as  is  obviously  more  probable,  he  banks 
elsewhere  —  perhaps  at  Lloyd's  —  he  will  pay  your  cheque 
into  his  account  at  Lloyd's  bank,  and  it  will  be  the  creditor  of 
Parr's  for  the  amount  of  £1,050.  In  actual  fact,  of  course, 
so  small  a  transaction  would  be  swallowed  up  in  the  vast  mass 
of  the  cross-entries  which  each  of  the  banks  every  day  makes 
against  all  the  others,  and  would  be  a  mere  needle  in  a  bottle 
of  hay.  But  for  the  sake  of  clearness  we  will  suppose  that 
this  little  cheque  is  the  only  transaction  between  Parr's  and 
Lloyd's  on  the  day  on  which  it  is  presented;  the  result  would 
be  that  Parr's  would  transfer  to  Lloyd's  £1,050  of  its  balance 
at  the  Bank  of  England,  where  all  the  banks  keep  an  account 
for  clearing  purposes.  And  the  final  outcome  of  the  operation 


144  BANKING  OPERATIONS  AND  ACCOUNTS 

\vould  be  that  Parr's  would  have  £1,050  more  "  advances  to 
customers"  and  £1,050  less  cash  at  the  Bank  of  England 
among  its  assets,  while  Lloyd's  would  have  £1,050  more  de- 
posits and  £1,050  more  cash  at  the  Bank  of  England.  And 
the  £1,050  increase  in  Lloyd's  deposits  would  have  been  created 
by  your  loan,  and  though  it  will  be  drawn  against  by  the  man 
who  sold  you  the  car,  it  will  only  be  transferred  perhaps  in 
smaller  fragments  to  the  deposits  of  other  banks ;  and  as  long 
as  your  loan  is  outstanding  there  will  be  a  deposit  against  it  in 
the  books  of  one  bank  or  another,  unless,  as  is  most  unlikely, 
it  is  used  for  the  withdrawal  of  coin  or  notes;  and  even  then 
the  coin  and  notes  are  probably  paid  into  some  other  bank,  and 
become  a  deposit  again;  and  so  we  come  back  to  our  original 
conclusion  that  your  borrowing  of  £1,050  has  increased  the 
sum  of  banking  deposits,  as  a  whole,  by  that  amount. 

The  same  reasoning  applies  whenever  a  bank  makes  a  loan, 
whatever  be  the  collateral,  or  pledge  deposited  by  the  borrower, 
whether  Stock  Exchange  securities,  as  in  the  case  cited,  or 
bales  of  cotton  or  tons  of  copper;  Or,  again,  whenever  it  dis- 
counts a  bill.  In  each  case  it  gives  the  borrower  or  the  seller 
of  the  bill  a  credit  in  its  books  —  in  other  words,  a  deposit ; 
and  though  this  deposit  is  probably  —  almost  certainly  — 
transferred  to  another  bank,  the  sum  of  banking  deposits  is 
thereby  increased,  and  remains  so,  as  long  as  the  loans  are  in 
existence.  And  so  it  appears  that  the  loans  of  one  bank  make 
the  deposits  of  others,  and  its  deposits  consist  largely  of  other 
banks'  loans.  .  .  . 

RELATION   BETWEEN   RESERVES  AND  DEMAND  LIABILITIES 

AGAIN 

1.  .  .  a  bank  must  so  regulate  its  loans  and  note  issues  as 
to  keep  on  hand  a  sufficient  cash  reserve,  and  thus  prevent 
insufficiency  of  cash  from  .  .  .  threatening.  It  can  regulate 
the  reserve  by  alternately  selling  securities  for  cash  and  loan- 
ing cash  on  securities.  The  more  the  loans  in  proportion  to 
the  cash  on  hand,  the  greater  the  profits,  but  the  greater  the 
danger  also.  In  the  long  run  a  bank  maintains  its  necessary 

1  Irving  Fisher,  The  Purchasing  Power  of  Money,  pp.  45~47-  The  Mac- 
millan  Company.  New  York.  1911, 


RESERVE  REQUIREMENTS  145 

reserve  by  means  of  adjusting  the  interest  rate  charged  for 
loans.  If  it  has  few  loans  and  a  reserve  large  enough  to  sup- 
port loans  of  much  greater  volume,  it  will  endeavor  to  ex- 
tend its  loans  by  lowering  the  rate  of  interest.  If  its  loans 
are  large  and  it  fears  too  great  demands  on  the  reserve,  it 
will  restrict  the  loans  by  a  high  interest  charge.  Thus,  by 
alternately  raising  and  lowering  interest,  a  bank  keeps  its  loans 
within  the  sum  which  the  reserve  can  support,  but  endeavors 
to  keep  them  (for  the  sake  of  profit)  as  high  as  the  reserve 
will  support. 

If  the  sums  owed  to  individual  depositors  are  large,  rela- 
tively to  the  total  liabilities,  the  reserve  should  be  proportion- 
ately large,  since  the  action  of  a  small  number  of  depositors 
can  deplete  it  rapidly.  Similarly,  the  reserves  should  be 
larger  against  fluctuating  deposits  (as  of  stock  brokers)  or 
those  known  to  be  temporary.  The  reserve  in  a  large  city  of 
great  bank  activity  needs  to  be  greater  in  proportion  to  its 
demand  liabilities  than  in  a  small  town  with  infrequent  bank- 
ing transactions. 

Experience  dictates  differently  the  average  size  of  deposit 
accounts  for  different  banks  according  to  the  general  char- 
acter and  amount  of  their  business.  For  every  bank  there  is 
a  normal  ratio  and  hence  for  a  whole  community  there  is  also 
a  normal  ratio  —  an  average  of  the  ratios  for  the  different 
banks.  No  absolute  numerical  rule  can  be  given.  Arbitrary 
rules  are  often  imposed  by  law.  National  banks  in  the  United 
States,  for  instance,  are  required  to  keep  a  reserve  for  their 
deposits,  varying  according  as  they  are  or  are  not  situated  in 
certain  cities  designated  by  law  as  "  reserve  "  cities,  i.  e.,  cities 
where  national  banks  hold  deposits  of  banks  elsewhere. 
These  reserves  are  all  in  defense  of  deposits.  In  defense  of 
notes,  on  the  other  hand,  no  cash  reserve  is  required  —  that  is, 
of  national  banks.  True,  the  same  economic  principles  apply 
to  both  bank  notes  and  deposits,  but  the  law  treats  them  differ- 
ently. The  Government  itself  chooses  to  undertake  to  redeem 
the  national  bank  notes  on  demand. 

The  state  banks  are  subject  to  varying  restrictions.  Thus 
the  requirement  as  to  the  ratio  of  reserve  to  deposits  varies 
from  12^2  per  cent,  to  22^/2  per  cent.,  being  usually  between 


146  BANKING  OPERATIONS  AND  ACCOUNTS 

15  per  cent,  and  20  per  cent.  Of  the  reserve,  the  part  which 
must  be  cash  varies  from  10  per  cent,  (of  the  reserve)  to  50 
per  cent.,  usually  40  per  cent. 

Such  legal  regulation  of  banking  reserves,  however,  is  not 
a  necessary  development  of  banking.  .  .  . 

THE    ROLE    OF    A    SPECIE    RESERVE    ILLUSTRATED    BY    THE    IN- 
CONVERTIBLE  NOTES   OF  THE   BANK   OF   ENGLAND   ISSUED 
DURING  THE  OPERATION  OF  THE  RESTRICTION  ACT  X 

2.  .  .  Your  Committee  proceeded,  in  the  first  instance,  to 
ascertain  what  the  price  of  gold  bullion  [in  terms  of  Bank  of 
England  notes]  had  been,  as  well  as  the  rates  of  the  foreign 
exchanges,  for  some  time  past;  particularly  during  the  last 
year. 

Your  Committee  have  found  that  the  price  of  gold  bullion, 
which,  by  the  regulations  of  his  Majesty's  Mint,  is 
£3  i?s.  ioy2d.  per  ounce  of  standard  fineness,  was,  during 
the  years  1806,  1807,  and  1808,  as  high  as  £4  in  the  market. 
Towards  the  end  of  1808  it  began  to  advance  very  rapidly, 
and  continued  very  high  during  the  whole  year  1809;  the 
market  price  of  standard  gold  in  bars  fluctuating  from 
£4  9^.  to  £4  12.?.  per  ounce.  The  market  price  at  £4  los.  is 
about  15^2  per  cent,  above  the  Mint  price.  .  .  . 

It  is  due,  ...  in  justice  to  the  present  Directors  of  the 
Bank  of  England,  to  remind  the  House  that  the  suspension  of 
their  cash  payments,  though  it  appears  in  some  degree  to  have 
originated  in  a  mistaken  view  taken  by  the  Bank  of  the 
peculiar  difficulties  of  that  time,  was  not  a  measure  sought 
for  by  the  Bank,  but  imposed  upon  it  by  the  Legislature  for 
what  were  held  to  be  urgent  reasons  of  state  policy  and  public 
expediency.  And  it  ought  not  to  be  urged  as  matter  of  charge 
against  the  Directors,  if  in  this  novel  situation  in  which  their 
commercial  company  was  placed  by  the  law,  and  entrusted 
with  the  regulation  and  control  of  the  whole  circulating 

^  1  This  act,  passed  in  1797  in  order  to  prevent  a  drain  of  gold  to  the  con- 
tinent during  the  Napoleonic  War,  forbade  the  Bank  of  England  to  re- 
deem its  notes.  It  remained  in  force  until  1821,  when  specie  payment 
was  resumed. —  EDITOR. 

-  Report  from  the  Select  Committee  on  the  High  Price  of  Gold  Bullion. 
Ordered  by  the  House  of  Commons,  to  be  printed,  8  June,  1810. 


FUNCTION  OF  A  SPECIE  RESERVE  147 

medium  of  the  country,  they  were  not  fully  aware  of  the 
principles  by  which  so  delicate  a  trust  should  be  executed,  but 
continued  to  conduct  their  business  of  discounts  and  advances 
according  to  their  former  routine. 

It  is  important  at  the  same  time  to  observe  that  under  the 
former  system,  when  the  Bank  was  bound  to  answer  its  notes 
in  specie  upon  demand,  the  state  of  the  foreign  exchanges  and 
the  price  of  gold  did  most  materially  influence  its  conduct  in 
the  issue  of  those  notes,  though  it  was  not  the  practice  of  the 
Directors  systematically  to  watch  either  the  one  or  the  other. 
So  long  as  gold  was  demandable  for  their  paper,  they  were 
speedily  apprised  of  a  depression  of  the  exchange,  and  a  rise 
in  the  price  of  gold,  by  a  run  upon  them  for  that  article.  If 
at  any  time  they  incautiously  exceeded  the  proper  limit  of 
their  advances  and  issues,  the  paper  was  quickly  brought  back 
to  them,  by  those  who  were  tempted  to  profit  by  the  market 
price  of  gold  or  by  the  rate  of  exchange.  In  this  manner  the 
evil  soon  cured  itself.  The  Directors  of  the  Bank  having 
their  apprehensions  excited  by  the  reduction  of  their  stock 
of  gold,  and  being  able  to  replace  their  loss  only  by  reiterated 
purchases  of  bullion  at  a  very  losing  price,  naturally  contracted 
their  issues  of  paper,  and  thus  gave  to  the  remaining  paper,  as 
well  as  to  the  coin  for  which  it  was  interchangeable,  an 
increased  value,  while  the  clandestine  exportation  either  of 
the  coin,  or  the  gold  produced  from  it,  combined  in  improving 
the  state  of  the  exchange  and  in  producing  a  corresponding 
diminution  of  the  difference  between  the  market  price  and 
Mint  price  of  gold,  or  of  paper  convertible  into  gold. 

Your  Committee  do  not  mean  to  represent  that  the  manner 
in  which  this  effect  resulted  from  the  conduct  which  they 
have  described,  was  distinctly  perceived  by  the  Bank  Directors. 
The  fact  of  limiting  their  paper  as  often  as  they  experienced 
any  great  drain  of  gold,  is,  however,  unquestionable.  .  .  . 

It  was  a  necessary  consequence  of  the  suspension  of  cash 
payments,  to  exempt  the  Bank  from  that  drain  of  gold,  which, 
in  former  times,  was  sure  to  result  from  an  unfavourable  ex- 
change and  a  high  price  of  bullion.  And  the  Directors,  re- 
leased from  all  fears  of  such  a  drain,  and  no  longer  feeling 
any  inconvenience  from  such  a  state  of  things,  have  not  been 


148  BANKING  OPERATIONS  AND  ACCOUNTS 

prompted  to  restore  the  exchanges  and  the  price  of  gold  to 
their  proper  level  by  a  reduction  of  their  advances  and  issues. 
The  Directors,  in  former  times,  did  not  perhaps  perceive  and 
acknowledge  the  principle  more  distinctly  than  those  of  the 
present  day,  but  they  felt  the  inconvenience,  and  obeyed  its 
impulse;  which  practically  established  a  check  and  limitation 
to  the  issue  of  paper.  In  the  present  times  the  inconvenience 
is  not  felt;  and  the  check,  accordingly,  is  no  longer  in 
force.  .  .  . 

By  far  the  most  important  .  .  .  consequence  .  .  .  [of  the 
Restriction  Act]  is,  that  while  the  convertibility  into  specie 
no  longer  exists  as  a  check  to  an  overissue  of  paper,  the  Bank 
Directors  have  not  perceived  that  the  removal  of  that  check 
rendered  it  possible  that  such  an  excess  might  be  issued  by 
the  discount  of  perfectly  good  bills.  So  far  .from  perceiving 
this  .  .  .  they  maintain  the  contrary  doctrine  with  the  utmost 
confidence.  .  .  .  That  this  doctrine  is  a  very  fallacious  one, 
your  Committee  cannot  entertain  a  doubt.  The  fallacy,  upon 
which  it  is  founded,  lies  in  not  distinguishing  between  an  ad- 
vance of  capital  to  merchants,  and  an  addition  of  supply  of 
currency  to  the  general  mass  of  circulating  medium.  If  the 
advance  of  capital  only  is  considered,  as  made  to  those  who 
are  ready  to  employ  it  in  judicious  and  productive  undertak- 
ings, it  is  evident  there  need  be  no  other  limit  to  the  total 
amount  of  advances  than  what  the  means  of  the  lender,  and 
his  prudence  in  the  selection  of  borrowers,  may  impose.  But 
in  the  present  situation  of  the  Bank,  intrusted  as  it  is  with  the 
function  of  supplying  the  public  with  that  paper  currency 
which  forms  the  basis  of  our  circulation,  and  at  the  same  time 
not  subjected  to  the  liability  of  converting  the  paper  into 
specie,  every  advance  which  it  makes  of  capital  to  the  mer- 
chants in  the  shape  of  discount,  becomes  an  addition  also  to 
the  mass  of  circulating  medium.  In  the  first  instance,  when 
the  advance  is  made  by  notes  paid  in  discount  of  a  bill,  it  is 
undoubtedly  so  much  capital,  so  much  power  of  making  pur- 
chases, placed  in  the  hands  of  the  merchant  who  receives  the 
notes;  and  if  those  hands  are  safe,  the  operation  is  so  far, 
and  in  this  its  first  step,  useful  and  productive  to  the  public. 
But  as  soon  as  the  portion  of  circulating  medium  in  which  the 


FUNCTION  OF  A  SPECIE  RESERVE  149 

advance  was  thus  made  performs  in  the  hands  of  him  to  whom 
it  was  advanced  this  its  first  operation  as  capital,  as  soon  as 
the  notes  are  exchanged  by  him  for  some  other  article  which 
is  capital,  they  fall  into  the  channel  of  circulation  as  so  much 
circulating  medium,  and  form  an  addition  to  the  mass  of  cur- 
rency. The  necessary  effect  of  every  such  addition  to  the 
mass  is  to  diminish  the  relative  value  of  any  given  portion 
of  that  mass  in  exchange  for  commodities.  If  the  addition 
were  made  by  notes  convertible  into  specie,  this  diminution  of 
the  relative  value  of  any  given  portion  of  the  whole  mass 
would  speedily  bring  back  upon  the  Bank  which  issued  the 
notes  as  much  as  was  excessive.  But  if  by  law  they  are  not  so 
convertible,  of  course  this  excess  will  not  be  brought  back,  but 
will  remain  in  the  channel  of  circulation,  until  paid  in  again 
to  the  Bank  itself  in  discharge  of  the  bills  which  were  origi- 
nally discounted.  During  the  whole  time  they  remain  out, 
they  perform  all  the  functions  of  circulating  medium;  and 
before  they  come  to  be  paid  in  discharge  of  those  bills,  they 
have  already  been  followed  by  a  new  issue  of  notes  in  a  similar 
operation  of  discounting.  Each  successive  advance  repeats 
the  same  process.  If  the  whole  sum  of  discounts  continues 
outstanding  at  a  given  amount,  there  will  remain  permanently 
out  in  circulation  a  corresponding  amount  of  paper;  and  if 
the  amount  of  discounts  is  progressively  increasing,  the 
amount  of  paper,  which  remains  out  in  circulation  over  and 
above  what  is  otherwise  wanted  for  the  occasions  of  the 
public,  will  progressively  increase  also,  and  the  money  prices 
of  commodities  will  progressively  rise.  This  progress  may 
be  as  indefinite  as  the  range  of  speculation  and  adventure  in 
a  great  commercial  country.  .  .  . 


CHAPTER  X 

THE  USE  OF  CREDIT  INSTRUMENTS  IN  PAY- 
MENTS IN  THE  UNITED  STATES 

1  DISCUSSIONS  concerning  the  issue  of  notes  by  banking  in- 
stitutions, which  largely  occupied  the  attention  of  students  of 
finance  and  business  men  in  the  eighteenth  and  the  first  three 
quarters  of  the  nineteenth  centuries,  have  been  succeeded  by 
equally  intense  discussions  of  the  amount  and  influence  of 
credit  deposits  on  the  books  of  the  banks,  when  drawn  on  by 
their  customers  with  checks.  The  fact  that  the  use  of  checks 
against  deposits  renders  unnecessary  a  large  amount  of 
money,  or  currency,  attracted  attention  early  in  the  history 
of  deposit  banking,  and  efforts  have  been  made  from  time  to 
time  to  determine  the  proportion  of  money,  or  currency,  re- 
placed with  checks  and  credit  documents  of  similar  char- 
acter.2 

We  may  summarize  the  results  of  our  inquiry  and  inferences 
therefrom  briefly  as  follows: 

1.  In  the  first  place,  it  is  very  clear  that  a  large  proportion 
of  the  business  of  the  country,  even  the  retail  trade,  is  done  by 
means  of  credit  instruments.     While  it  is  probably  true  that 
wage-earners,  as  a  class,  do  not  commonly  use  checks,  it  is 
also  true  that  a  great  many  of  them  do.     Moreover,  the  use 
of  checks  is  common  among  people  who  derive  their  income 
from  other  sources,  even  though  it  be  not  larger  than  the  well- 
paid  day  laborer.     We  are  justified  ...  in  concluding  that 
50  or  60  per  cent,  of  the  retail  trade  of  the  country  is  settled 
in  this  way. 

2.  ...  Over  90  per  cent,  of  the  wholesale  trade  of  the 
country  is  done  with  checks  and  other  credit  documents. 

1  David  Kinley,  The  Use  of  Credit  Instruments  in  Payments  in  the 
United  States,  pp.  i,  2;  199-216.  Senate  Document  No.  399.  6ist  Congress, 
,?d  Session. 

-  In  this  discussion  the  phrase  "  credit  documents "  or  "  credit  instru- 
ments "  does  not  include  bank  notes. 

ISO 


CREDIT  INSTRUMENTS  IN  PAYMENTS  151 

3.  The  very  general  use  of  checks  is  shown  in  the  deposits 
of  "  all  other  "  depositors.     The  average  is  close  up  to  that 
of  the  wholesale  trade,  and  while  many  corporations,  public 
and  private,  are  doubtless  represented  here,  and  many  specu- 
lative transactions  are  included,  there  is  no  reason  for  exclud- 
ing any  one  of  those  in  determining  the  proportion  of  business 
done,  whatever  we  may  think  of  its  legitimacy  from  the  point 
of  view  of  public  morals  or  public  utility. 

4.  The  use  of  checks  is  promoted  in  a  measure  by  the  pay- 
ment of  wages  by  check.     It  appears  from  our  investigation 
that  of  weekly  pay  rolls  reported  by  the  banks,  aggregating 
$134,800,000  for  the  week  ending  March  13  last,  70  per  cent, 
was  in  checks.  .  .  . 

5.  The  great  use  of  checks  is  shown  also  by  the  large 
number  of  accounts  under  $500.  .  .  . 

6.  We  may  therefore  safely  accept  an  average  of  80  to  85 
per  cent,  as  the  probable  percentage  of  business  of  this  country 
clone  by  check. 

7.  The  fact  that  so  large  a  proportion  of  business  is  done 
with  credit  paper  may  or  may  not  be  a  good  thing.     Whether 
it  is  or  not  depends  on  circumstances.     If  any  part  of  the 
country  is  compelled  to  use  checks  because  of  the  lack  oi 
currency,  when  it  would  prefer  the  latter,  the  situation  is  an 
evil. 

8.  The  transaction  of  so  large  a  volume  of  our  business  by 
checks  is  an  element  of  danger  in  times  of  stringency  and 
crisis.     In  such  times  the  uncalled  balance  of  credit  transac- 
tions creates  a  larger  demand  for  money,  but  the  habit  of 
settling  by  check  has  meantime  kept  the  available  amount  of 
money  at  a  minimum. 

9.  Consequently  there  ought  to  be  some  means  of  supplying 
additional  currency  when  credit  as  a  means  of  payment  dimin- 
ishes.    This  currency  ought  to  be  as  safe  and  as  uniform  as 
the  ordinary  currency,   and   it   should  be  capable  of  being 
quickly  emitted  and  recalled.     That  is,  it  should  possess  elas- 
ticity. 

10.  The  large  money  circulation  of  the  country  is  explained 
by  the  facts  that  our  prices  and  wages  range  high,  that  our 
people  probably  carry  a  larger  average  amount  of  money  on 


152  CREDIT  INSTRUMENTS  IN  PAYMENTS 

their  persons  than  do  foreigners,  that  some  portion  of  our 
currency  has  been  destroyed  or  lost  or  hoarded.  ...  As  our 
business  grows,  the  amount  of  money  needed  as  reserve  to 
perform  this  vast  volume  of  business  transactions  increases, 
too.  .  .  . 

13.  The  volume  of  credit  transactions  very  likely  tends  to 
increase  as  population  and  business  grow.  It  does  not  in- 
crease uniformly,  however,  but  by  periodic  movements.  That 
is  to  say,  the  rate  of  increase  of  credit  transactions,  as  com- 
pared with  the  whole  volume  of  business,  grows,  as  it  were,  by 
jerks  and  at  a  decreasing  rate. 

Several  important  questions  are  closely  related  to  the  in- 
quiry which  has  been  [made  and  summarized].  Among 
them  are  these : 

1.  What  is  the  amount  of  money  rendered- unnecessary  by 
the  use  of  credit  paper? 

2.  What  is  the  influence  of  the  vast  volume  of  credit  trans- 
actions on  the  value  of  money  or  the  level  of  prices?  1 

3.  Why  is  it  that  our  per  capita  circulation  is  so  large  and 
where  is  the  money  in  active  circulation?  .  .  . 

i.  We  will  take  these  questions  up  in  order.  .  .  .  No  one 
can  say  .  .  .  with  definiteness  \vhat  is  the  amount  of  money 
released  if  75  or  80  per  cent,  of  our  business  transactions  are 
settled  by  means  of  credit  paper.  This  is  a  matter  in  which 
the  long  experience  of  practical  bankers  is  the  only  safe  guide, 
because  the  amount  in  question  is  changing  from  day  to  day 
as  the  conditions  change.  No  simple  rule  about  it  can  be  laid 
down.  .  .  . 

One  point  needs  to  be  carefully  borne  in  mind.  However 
great  the  volume  of  credit  exchanges,  however  extensive  the 
use  of  credit  may  become  in  a  community,  they  can  never 
fully  displace  sales  for  direct  money  payment.  The  extensive 
use  of  credit  is  not  of  itself  a  sign  that  a  community  is  well 
off.  Credit  is  used  in  poor  as  well  as  in  rich  communities. 
Its  extensive  use  in  a  poor  and  undeveloped  country  is  likely 
.to  indicate  a  lack  of  capital  rather  than  an  abundance  of 

1  [The  effect  of  credit  exchanges  on  the  value  of  money,  treated  at 
length  in  the  next  chapter,  is  only  briefly  discussed  in  the  extracts  here 
reproduced.] 


CREDIT  INSTRUMENTS  IN  PAYMENTS  153 

wealth.  Every  community  tends  to  use  the  cheapest  medium 
of  exchange  accessible  to  it.  If  its  capital  is  of  very  high 
value  for  producing  goods  for  direct  consumption,  a  com- 
munity will  be  averse  to  investing  much  of  it  in  a  medium  of 
exchange. 

This  is  the  reason  why  undeveloped  countries,  as  our  own 
was  a  century  ago,  try  to  effect  their  exchanges  by  means  of 
credit  paper  to  a  larger  extent  than  wealthier  communities. 
Under  such  conditions  paper  money  is  commonly  thought  to 
be  the  cheapest  medium  of  exchange.  If,  now,  part  of  the 
money  exchanges  are  replaced  with  credit  exchanges,  the 
amount  of  money  released,  or  the  amount  without  which  the 
community  could  now  get  on,  would  be  the  whole  amount 
formerly  used  in  money  payments  .  .  .  minus  the  reserve 
necessary  to  do  this  credit  business.  The  important  point, 
however,  is  that  less  money  is  necessary.  How  much  less  we 
can  not  be  sure.  We  can  get  some  light  on  the  subject,  how- 
ever, by  noting  the  volume  of  business  done  by  credit  paper 
and  the  balances  which  from  time  to  time  are  carried  as  a  basis 
of  settlement. 

It  is  important  to  note  also  that  an  increase  in  the  volume 
of  credit  transactions  does  not  necessarily  mean  that  we  must 
get  a  proportionate  increase  in  our  reserve  of  money.  Every 
refinement  of  the  credit  mechanism  makes  it  possible  to  do  a 
larger  volume  of  business  on  the  same  reserve.  .  .  . 

The  volume  of  business  that  can  be  done  by  credit  paper 
depends  on  several  circumstances.  Obviously,  in  the  first 
place,  it  depends  upon  the  banking  facilities  of  the  country. 
If  the  banks  are  widely  distributed,  if  they  are  willing  to  deal 
in  transactions  small  enough  to  be  within  the  reach  of  large 
numbers  of  people,  many  more  transactions  will  be  settled 
through  them  than  would  otherwise  be  the  case.  This  fact 
undoubtedly  explains  in  large  measure  the  development  of 
what  may  be  called  the  "  banking  habit "  among  the  people 
of  the  United  States.  Undoubtedly  our  people  pay  by  check 
much  more  commonly  and  much  more  largely  than  people  of 
any  other  country.  We  settle  smaller  transactions  by  check; 
our  banks  are  willing  to  carry  smaller  accounts.  Indeed,  the 
rapid  industrial  development  of  our  country  is  probably  due 


154  CREDIT  INSTRUMENTS  IN  PAYMENTS 

in  no  small  degree  to  our  system  of  independent  banks  and 
the  facility  with  which  we  have  permitted  banks  to  be  estab- 
lished. The  small  independent  bank  in  the  country  com- 
munity has  felt  that  its  interests  and  success  were  bound  up 
with  the  interests  and  success  of  the  community,  and,  there- 
fore, has  undoubtedly  been  willing  to  do  more  for  the  general 
interests  than  a  branch  of  a  large  bank  in  some  remote  com- 
mercial center  would  have  felt  like  doing,  even  if  it  had  been 
justified  in  doing  so.  The  small  capital  with  which  we  have 
permitted  banks  to  be  established  also  has  undoubtedly  been 
a  contributing  factor  to  our  rapid  economic  development,  as 
well  as  to  the  promotion  of  the  banking  habit  among  our 
people. 

In  the  next  place,  the  density  of  population  is,  of  course,  an 
important  factor  for  the  growth  of  credit  exchanges.  A 
larger  volume  of  business  is  settled  by  bank  paper  in  a  com- 
mercial center  than  in  an  agricultural  community,  even  though 
the  proportion  of  total  business  thus  settled  may  not  be  larger. 
However,  it  is  necessary  that  there  should  be  a  certain  number 
of  people  within  reach  of  a  common  center  in  order  to  have 
a  bank  established  there.  Of  course  the  smaller  the  bank  the 
fewer  the  people  thus  required.  Thus  again  our  inclination 
in  the  past  to  favor  the  establishment  of  the  small  independent 
banks  has  facilitated  the  spread  of  banking  and  promoted  the 
volume  of  business  settled  in  the  country  districts  by  credit 
payment  and  stimulated  the  banking  habit  among  our  people. 

Finally,  the  general  education  and  intelligence  of  the  mass 
of  the  people  is  an  important  factor.  Men  do  not  use  banks 
unless  they  have  confidence  in  them,  and  they  have  come  to  be 
regarded  as  a  settled  part  of  the  ordinary  commercial  mechan- 
ism of  the  community.  Our  people  are  people  of  a  wide  gen- 
eral education  and  high  order  of  intelligence.  They  under- 
stand the  place  and  work  of  the  bank  in  a  community  much 
better  than  the  same  number  of  people,  for  example,  in  a 
European  country.  This  fact  is  strikingly  brought  out  by  a 
study  of  the  proportion  of  retail  business  settled  by  means  of 
checks  in  what  are  called  the  "  foreign  "  districts  of  our 
large  cities,  on  the  one  hand,  and  in  an  agricultural  community 
on  the  other.  The  European  immigrant  is  not  a  man  who 


CREDIT  INSTRUMENTS  IN  PAYMENTS  155 

has  had  banking  connections  in  his  home  country,  and  he  does 
not  use  them  here,  even  though  the  facilities  are  more 
numerous. 

Such  evidence  as  there  is  seems  to  indicate  that  payment  by 
check  has  shown  an  increase  during  the  past  few  years : 

(a)  In  the  first  place,  the  returns  of  our  reports  show  a 
larger  percentage  in  retail  trade.  .  .  . 

(b)  The  prosperity  of  the  farmers  in  the  Central  West  has 
enabled  many  to  have  bank  accounts  who  fifteen  years  ago 
could  not  carry  balances.     The   writer's   information   from 
central  Illinois  is  strongly  in  this  direction. 

(c)  The  third  evidence  is  found  in  the  growth  of  the  num- 
ber of  small  banks,  especially  in  the  country  districts.  .  .  . 

(d)  The    appearance    of    a    considerable    proportion    of 
checks  in  the  deposits  of  mutual  savings  banks  is  also,  to 
some  degree,  significant.  .  .  . 

On  the  other  hand,  the  increase  of  that  part  of  the  popula- 
tion which  consists  of  the  wage-earning  class,  by  whom  the 
use  of  checks  is  small,  is  undoubtedly  greater  than  that  of 
our  other  classes  of  population.  However,  the  wealthy 
classes,  though  fewer  in  number,  have  more  to  spend  and 
their  use  of  checks  raises  the  proportion  of  credit  paper  in 
payments. 

We  can  not  expect  any  social  movement  to  continue  steadily 
in  one  direction  for  an  indefinite  time.  Such  evidence  as  in- 
quiries of  this  character  furnish  seems  to  show  that  there  is  a 
certain  ebb  and  flow  in  the  proportion  of  checks  used  in  busi- 
ness payments.  With  a  given  amount  of  money  a  certain  pro- 
portion of  it  can  be  used  for  bank  reserves  on  which  to  build 
credit  transactions.  For  a  time  the  volume  of  business  will 
increase  more  rapidly  than  the  money  supplies,  so  that  the 
proportion  of  credit  business  to  the  whole  will  increase,  the 
improvement  of  the  credit  machinery  in  the  meantime  facili- 
tating the  movement.  But  the  perfection  of  the  facilities  for 
utilizing  to  the  utmost  a  given  reserve,  or  a  slowly  increasing 
one,  will  come  to  a  stop  after  a  time,  and  it  will  be  necessary 
to  increase  the  money  supply  for  any  further  expansion  of 
credit.  In  the  language  of  business,  another  unit  of  capital 
must  be  added  to  plant.  The  unit  added  to  the  social  capital 


156  CREDIT  INSTRUMENTS  IN  PAYMENTS 

devoted  to  exchange  —  that  is,  the  additional  amount  of 
money  —  will  be  larger  than  is  necessary  for  most  profitable 
immediate  use,  consequently  the  proportion  of  money  ex- 
changes will  for  a  time  show  an  increase.  We  may  conclude, 
therefore,  that  the  volume  of  business  done  on  credit  gradually 
increases  as  the  population  and  total  amount  of  business  are 
enlarged,  but  at  a  decreasing  rate  and  with  occasional  or 
periodic  retardations. 

2.  Relation  of  credit  exchanges  to  the  volume  of  money 
and  prices. — •  It  is  pertinent  to  inquire,  now,  what  effect,  if 
any,  this  great  settlement  of  indebtedness  by  means  of  credit 
paper  has  upon  the  value  of  money.  Evidently,  it  can  influ- 
ence this  value,  or  the  general  price  level,  only  as  it  changes 
the  amount  of  demand  for  money.  We  have  seen  reason, 
now,  to  think  that  80  per  cent,  of  our  business  transactions 
are  settled  by  means  of  credit  paper.  Credit  paper  cancella- 
tion enables  a  larger  amount  of  business  to  be  done  with  the 
same  amount  of  money  and  has  an  effect  in  determining  the 
value  of  money  by  increasing  the  demand  for  reserves.  .  .  . 

.  .  .  The  use  of  credit  paper  in  effecting  credit  exchanges 
makes  possible  a  far  larger  volume  of  business  than  could 
otherwise  be  done,  and  that  this  increased  volume  of  business 
must  in  some  way  influence  prices  seem[s]  undeniable.  .  .  . 

.  .  .  We  are  told  by  many  that  there  is  a  vast  amount  of 
credit  transactions  embodied  in  banking  and  clearing-house 
statistics  which  may  be  termed  "  fictitious."  That  is  to  say, 
they  are  not  a  part  of  the  necessary  work  of  exchange  in  a 
community.  For  example,  the  cotton  and  wheat  crops  are 
sold  several  times  over  on  the  exchanges  of  the  country,  but 
not  all  these  purchases  and  sales  are  a  necessary  part  of  the 
process  of  getting  the  cotton  from  the  planter  to  the  manufac- 
turer. These  sales,  we  are  told,  are  purely  speculative  and 
born  out  of  the  credit  organization,  which,  it  is  urged,  merely 
makes  the  transactions  possible.  .  .  .  However,  .  .  .  these 
exchanges  actually  exist.  All  the  purchases  involved  consti- 
tute a  part  of  the  demand  for  means  of  settlement.  There- 
fore they  are  to  be  regarded  as  a  proper  part  of  the  exchange 
business  of  the  country,  and  in  some  degree  they  must  influ- 
ence the  need  for  money.  .  .  . 


CREDIT  INSTRUMENTS  IN  PAYMENTS  157 

.  .  .  The  demand  for  money  to  effect  exchanges  includes, 
first,  demand  for  money  for  direct  exchanges ;  second,  demand 
for  reserves  for  credit  exchanges.  Some  goods  exchange  by 
direct  barter  and  still  more  probably  by  indirect  barter.  If 
these  last  exchanges  just  cancelled  one  another,  the  credit 
paper  that  grows  out  of  them  would  also  cancel,  and  no  bal- 
ances would  remain  to  be  settled  with  money.  Usually,  how- 
ever, they  do  not  cancel,  and  the  balance  must  be  settled  with 
cash;  hence  a  reserve  is  necessary.  .  .  .  This  demand  for  re- 
serve is  certainly  one  of  the  influences  that  go  to  determine 
the  value  of  money.  In  short,  the  demand  for  money  includes 
a  demand  for  direct  payment  and  a  demand  for  reserve.  .  .  . 

3.  Our  monetary  circulation. —  Our  per  capita  circulation, 
as  estimated  by  the  Comptroller  of  the  Currency,  has  increased 
from  $21.10  in  1906  to  $34.72  in  igoS.1  This  is  larger  than 
the  per  capita  circulation  of  other  great  industrial  and  com- 
mercial countries  with  the  exception  of  France.  Why  is  it 
necessary  and  where  is  it?  It  is  necessary,  perhaps,  for  the 
following  reasons : 

(a)  A  larger  amount  of  money  is  needed  in  this  country 
because,  in  the  first  place,  our  prices  range  higher.     If  the 
prices  of  articles  commonly  consumed  range  20  per  cent,  higher 
than  they  do  abroad,  the  people  who  buy  them  and  pay  for 
them  with  money  need  a  larger  amount  to  make  their  pur- 
chases.    The  same  cause  makes  a  larger  reserve  necessary  to 
exchange  a  given  volume  of  goods  by  credit.     The  demand  for 
money,  therefore,  both  for  reserve  and  direct  money  transac- 
tions, is  greater  on  account  of  the  higher  scale  of  prices. 

(b)  The  same  kind  of  reasoning  applies  to  our  wage  scale. 
Whether  the  wage  scale  be  the  cause  of  the  higher  cost  of 
living  or  the  higher  cost  of  living  be  the  cause  of  the  higher 
wage  scale,  more  money  will  be  needed  in  proportion  to  the 
trade.     If  wages  are  paid  with  checks,  more  money  will  be 
needed  by  the  amount  that  the  reserve  must  be  increased  to 
furnish  a  basis  for  the  checks. 

(c)  Our  country  is  more  sparsely  settled  than  England, 
France,  or  Germany.     In  spite  of  the  large  increase  in  the 
banking  facilities  of  the  country,  it  still  remains  true  that  very 

1  [Approximately  $40  in  1916.] 


158  CREDIT  INSTRUMENTS  IN  PAYMENTS 

many  places  are  remote  from  banks,  so  that  business,  so  far 
as  it  is  not  barter,  will  probably  be  carried  on  with  money.  It 
is  necessary,  therefore,  to  have  a  larger  amount  of  money 
than  if  population  were  denser.  .  .  . 

(d)  It  may  be  that  our  spirit  of  individualism  plays  some 
part.     So  large  a  proportion  of  our  wage-earning  population 
have  come  from  conditions  where  they  had  opportunity  to 
handle  very  little  money,  that  they  like  to  carry  money  on  their 
persons.     It  makes  them  feel,  as  one  man  said  to  the  writer, 
"  more  independent."     To  quote  the   same   informant,   they 
would  "  rather  pay  higher  prices  and  have  more  money  to 
pay  with." 

(e)  Doubtless  there  is  a  good  deal  of  hoarding  by  people 
who  distrust  banks  "or  are  not  near  enough  to  use  them.     It 
might  be  urged  that  no  larger  proportion  of  people  here  hoard 
than  is  the  case  in  Europe.     Without  disputing  this,  it  is  true, 
however,  that  if  only  the  same  proportion  hoard  and  in  the 
same  relative  amounts  as  is  done  by  corresponding  classes  of 
the  population,  the  absolute  amount  thus  withdrawn  would  be 
larger  because  of  our  higher  scale  of  wages  and  prices.  .  .  . 


CHAPTER  XI 

A  SYMPOSIUM  ON  THE  RELATION  BETWEEN 
MONEY  AND  GENERAL  PRICES 

The  form  of  this  chapter  was  suggested  by  the  proceedings  of  a  ses- 
sion of  the  1910  Meeting  of  the  American  Economic  Association,  devoted 
to  a  consideration  of  the  causes  of  the  rise  in  prices  between  1896  and 
1909.  Selections  from  papers  there  presented,  and  from  the  relative  dis- 
cussion, make  up  a  considerable  part  of  the  chapter,  and  it  is  suggested 
that  all  of  the  selections,  except  the  last,  may  well  be  considered  for  pur- 
poses of  study  as  having  come  from  the  papers  and  discussion  of  the 
session  referred  to,  although  numerous  additions  and  substitutions  have 
been  made  in  order  to  render  the  treatment  one  of  principles  involved  in 
the  determination  of  general  prices  without  special  reference  to  any  partic- 
ular period  of  years. 

IRVING  FISHER  * :  Overlooking  the  influence  of  deposit 
currency,  or  checks,  the  price  level  may  be  said  to  depend  on 
only  three  sets  of  causes:  (i)  the  quantity  of  money  in  cir- 
culation; (2)  its  "efficiency"  or  velocity  of  circulation  (or 
the  average  number  of  times  a  year  money  is  exchanged  for 
goods)  ;  and  (3)  the  volume  of  trade  (or  amount  of  goods 
bought  by  money).  The  so-called  "quantity  theory,"2  i.e., 
that  prices  vary  proportionately  to  money,  has  often  been  in- 
correctly formulated,  but  (overlooking  checks)  the  theory  is 
correct  in  the  sense  that  the  level  of  prices  varies  directly  with 
the  quantity  of  money  in  circulation,  provided  the  velocity  of 
circulation  of  that  money  and  the  volume  of  trade  which  it 
is  obliged  to  perform  are  not  changed. 

The  quantity  theory  has  been  one  of  the  most  bitterly  con- 
tested theories  in  economics,  largely  because  the  recognition 

1  The  Purchasing  Power  of  Money,  pp.   14-71.    The  Macmillan  Com- 
pany.    New  York.     1911. 

2  This  theory,  though  often  crudely  formulated,  has  been  accepted  by 
Locke,  Hume,  Adam  Smith,  Ricardo,  Mill,  Walker,  Marshall,  Hadley,  Fet- 
ter, Kemmerer  and  most  writers  on  the  subject.     The  Roman  Julrus  Paulus, 
about  200  A.  D.,  stated  his  belief  that  the  value  of  money  depends  on  its 
quantity.     See  Zuckerkandl,  Theorie  des  Preises;  Kemmerer,  Money  and 
Credit  Instruments  in  their  Relation  to  General  Prices,  New  York  (Holt), 
1909.     It  is  true  that  many  writers  still  oppose  the  quantity  theory.     See 
especially,  Laughlin,  Principles  of  Money,  New  York  (Scribner).     1903. 

159 


160  MONEY  AND  PRICES 

of  its  truth  or  falsity  affected  powerful  interests  in  commerce 
and  politics.  It  has  been  maintained  —  and  the  assertion  is 
scarcely  an  exaggeration  —  that  the  theorems  of  Euclid  would 
be  bitterly  controverted  if  financial  or  political  interests  were 
involv.ed. 

The  quantity  theory  has,  unfortunately,  been  made  the  basis 
of  arguments  for  unsound  currency  schemes.  It  has  been  in- 
voked in  behalf  of  irredeemable  paper  money  and  of  national 
free  coinage  of  silver  at  the  ratio  of  16  to  I.  As  a  con- 
sequence, not  a  few  "  sound  money  men,"  believing  that  a 
theory  used  to  support  such  vagaries  must  be  wrong,  and  fear- 
ing the  political  effects  of  its  propagation,  have  drifted  into 
the  position  of  opposing,  not  only  the  unsound  propaganda, 
but  also  the  sound  principles  by  which  its  advocates  sought  to 
bolster  it  up.1  These  attacks  upon  the  quantity  theory  have 
been  rendered  easy  by  the  imperfect  comprehension  of  it  on 
the  part  of  those  who  have  thus  invoked  it  in  a  bad  cause. 

Personally,  I  believe  that  few  mental  attitudes  are  more  per- 
nicious, and  in  the  end  more  disastrous,  than  those  which 
would  uphold  sound  practice  by  denying  sound  principles  be- 
cause some  thinkers  make  unsound  application  of  those  prin- 
ciples. At  any  rate,  in  scientific  study  there  is  no  choice  but 
to  find  and  state  the  unvarnished  truth. 

The  quantity  theory  will  be  made  more  clear  by  the  equa- 
tion of  exchange,  which  is  now  to  be  explained. 

The  equation  of  exchange  is  a  statement,  in  mathematical 
form,  of  the  total  transactions  effected  in  a  certain  period  in 
a  given  community.  It  is  obtained  simply  by  adding  together 
the  equations  of  exchange  for  all  individual  transactions. 
Suppose,  for  instance,  that  a  person  buys  10  pounds  of  sugar 
at  7  cents  per  pound.  This  is  an  exchange  transaction,  in 
which  10  pounds  of  sugar  have  been  regarded  as  equal  to  70 
cents,  and  this  fact  may  be  expressed  thus:  70  cents  =  10 
pounds  of  sugar  multiplied  by  7  cents  a  pound.  Every  other 
sale  and  purchase  may  be  expressed  similarly,  and  by  adding 
them  all  together  we  get  the  equation  of  exchange  for  a  certain 

1  See  Scott,  "  It  has  been  a  most  fruitful  source  of  false  doctrines  re- 
garding monetary  matters,  and  is  constantly  and  successfully  employed  in 
defense  of  harmful  legislation  and  a^  a  means  of  preventing  needed  mone- 
tary reforms."  Mnnev  and  Banking  New  York,  1903,  p.  68. 


IRVING  FISHER  l6l 

period  in  a  given  community.  During  this  same  period,  how- 
ever, the  same  money  may  serve,  and  usually  does  serve,  for 
several  transactions.  For  that  reason  the  money  side  of  the 
equation  is  of  course  greater  than  the  total  amount  of  money 
in  circulation. 

The  equation  of  exchange  relates  to  all  the  purchases  made 
by  money  in  a  certain  community  during  a  certain  time.  We 
shall  continue  to  ignore  checks  or  any  circulating  medium  not 
money.  We  shall  also  ignore  foreign  trade  and  thus  restrict 
ourselves  to  trade  within  a  hypothetical  community.  Later 
we  shall  reinclude  these  factors,  proceeding  by  a  series  of 
approximations  through  successive  hypothetical  conditions  to 
the  actual  conditions  which  prevail  to-day.  We  must,  of 
course,  not  forget  that  the  conclusions  expressed  in  each  suc- 
cessive approximation  are  true  solely  on  the  particular  hypoth- 
esis assumed. 

The  equation  of  exchange  is  simply  the  sum  of  the  equa- 
tions involved  in  all  individual  exchanges  in  a  year.  In  each 
sale  and  purchase,  the  money  and  goods  exchanged  are  ipso 
facto  equivalent ;  for  instance,  the  money  paid  for  sugar  is 
equivalent  to  the  sugar  bought.  And  in  the  grand  total  of 
all  exchanges  for  a  year,  the  total  money  paid  is  equal  in 
value  to  the  total  value  of  the  goods  bought.  The  equation 
thus  has  a  money  side  and  a  goods  side.  The  money  side  is 
the  total  money  paid,  and  may  be  considered  as  the  product  of 
the  quantity  of  money  multiplied  by  its  rapidity  of  circula- 
tion. The  goods  side  is  made  up  of  the  products  of  quantities 
of  goods  exchanged  multiplied  by  their  respective  prices. 

The  important  magnitude,  called  the  velocity  of  circulation, 
or  rapidity  of  turnover,  is  simply  the  quotient  obtained  by 
dividing  the  total  money  payments  for  goods  in  the  course  of 
a  year  by  the  average  amount  of  money  in  circulation  by  which 
those  payments  are  effected.  This  velocity  of  circulation  for 
an  entire  community  is  a  sort  of  average  of  the  rates  of  turn- 
over of  money  for  different  persons.  Each  person  has  his 
own  rate  of  turnover  \vhich  he  can  readily  calculate  by  divid- 
ing the  amount  of  money  he  expends  per  year  by  the  average 
amount  he  carries. 

Let  us  begin  with  the  money  side.     If  the  number  of  dollars 


1 62  MONEY  AND  PRICES 

in  a  country  is  5,000,000,  and  their  velocity  of  circulation  is 
twenty  times  per  year,  then  the  total  amount  of  money  chang- 
ing hands  (for  goods)  per  year  is  5,000,000  times  twenty,  or 
$100,000,000.  This  is  the  money  side  of  the  equation  of  ex- 
change. 

Since  the  money  side  of  the  equation  is  $100,000,000,  the 
goods  side  must  be  the  same.  For  if  $100,000,000  has  been 
spent  for  goods  in  the  course  of  the  year,  then  $100,000,000 
worth  of  goods  must  have  been  sold  in  that  year.  In  order 
to  avoid  the  necessity  of  writing  out  the  quantities  and  prices 
of  the  innumerable  varieties  of  goods  which  are  actually  ex- 
changed, let  us  assume  for  the  present  that  there  are  only  three 
kinds  of  goods  —  bread,  coal,  and  cloth;  and  that  the  sales 
are: 

200,000,000  loaves  of  bread  at  $  .10  a  loaf, 
10,000,000  tons  of  coal  at  5.00  a  ton,  and 

30,000,000  yards  of  cloth  at       i.oo  a  yard. 

The  value  of  these  transactions  is  evidently  $100,000,000, 
i.  e.,  $20,000,000  worth  of  bread  plus  $50,000,000  worth  of 
coal  plus  $30,000,000  worth  of  cloth.  The  equation  of  ex- 
change therefore  (remember  that  the  money  side  consisted  of 
$5,000,000  exchanged  20  times)  is  as  follows: 

$5,000,000  X  20  times  a  year 

=  200,000,000  loaves  X  $  -io  a  loaf 
+  10,000,000  tons  X  5.00  a  ton 
+  30,000,000  yards  X  i.oo  a  yard 

This  equation  contains  on  the  money  side  two  magnitudes, 
viz.  (i)  the  quantity  of  money  and  (2)  its  velocity  of  cir- 
culation; and  on  the  goods  side  two  groups  of  magnitudes  in 
t\vo  columns,  viz.  ( i )  the  quantities  of  goods  exchanged 
(loaves,  tons,  yards),  and  (2)  the  prices  of  these  goods.  The 
equation  shows  that  these  four  sets  of  magnitudes  are  mutually 
related.  Because  this  equation  must  be  fulfilled,  the  prices 
must  bear  a  relation  to  the  three  other  sets  of  magnitudes  — 
quantity  of  money,  rapidity  of  circulation,  and  quantities  of 
goods  exchanged.  Consequently,  these  prices  must,  as  a 
whole,  vary  proportionally  with  the  quantity  of  money  and 
with  its  velocity  of  circulation,  and  inversely  with  the  quan- 
tities of  goods  exchanged. 


IRVING  FISHER  163 

Suppose,  for  instance,  that  the  quantity  of  money  were 
doubled,  while  its  velocity  of  circulation  and  the  quantities 
of  goods  exchanged  remained  the  same.  Then  it  would  be 
quite  impossible  for  prices  to  remain  unchanged.  The  money 
side  would  now  be  $10,000,000  X  20  times  a  year  or  $200,- 
000,000;  whereas,  if  prices  should  not  change,  the  goods 
would  remain  $100,000,000,  and  the  equation  would  be 
violated.  Since  exchanges,  individually  and  collectively, 
always  involve  an  equivalent  quid  pro  quo,  the  two  sides  must 
be  equal.  Not  only  must  purchases  and  sales  be  equal  in 
amount  —  since  every  article  bought  by  one  person  is  neces- 
sarily sold  by  another  —  but  the  total  value  of  goods  sold 
must  equal  the  total  amount  of  money  exchanged.  There- 
fore, under  the  given  conditions,  prices  must  change  in  such 
a  way  as  to  raise  the  goods  side  from  $100,000,000  to 
$200,000,000.  This  doubling  may  be  accomplished  by  an  even 
or  uneven  rise  in  prices  but  some  sort  of  a  rise  of  prices  there 
must  be.  If  the  prices  rise  evenly,  they  will  evidently  all  be 
exactly  doubled.  ...  If  the  prices  rise  unevenly,  the  doubling 
must  evidently  be  brought  about  by  compensation;  if  some 
prices  rise  by  less  than  double,  others  must  rise  by  enough  more 
than  double  to  exactly  compensate. 

But  whether  all  prices  increase  uniformly,  each  being  ex- 
actly doubled,  or  some  prices  increase  more  and  some  less 
(so  as  still  to  double  the  total  money  value  of  the  goods  pur- 
chased), the  prices  are  doubled  on  the  average.  .  .  .  From 
the  mere  fact,  therefore,  that  the  money  spent  for  goods  must 
equal  the  quantities  of  those  goods  multiplied  by  their  prices, 
it  follows  that  the  level  of  prices  must  rise  or  fall  according 
to  changes  in  the  quantity  of  money,  unless  there  are  changes 
in  its  velocity  of  circulation  or  in  the  quantities  of  goods  ex- 
changed. 

If  changes  in  the  quantity  of  money  affect  prices,  so  will 
changes  in  the  other  factors  —  quantities  of  goods  and  velocity 
of  circulation  —  affect  prices,  and  in  a  very  similar  manner. 
Thus  a  doubling  in  the  velocity  of  circulation  of  money  will 
double  the  level  of  prices,  provided  the  quantity  of  money  in 
circulation  and  the  quantities  of  goods  exchanged  for  money 
remain  as  before. 


1 64  MONEY  AND  PRICES 

Again,  a  doubling  in  the  quantities  of  goods  exchanged  will 
not  double,  but  halve,  the  height  of  the  price  level,  provided 
the  quantity  of  money  and  its  velocity  of  circulation  remain 
the  same.  .  .  . 

Finally,  if  there  is  a  simultaneous  change  in  two  or  all  of 
the  three  influences,  i.  e.,  quantity  of  money,  velocity  of  cir- 
culation, and  quantities  of  goods  exchanged,  the  price  level 
will  be  a  compound  or  resultant  of  these  various  influences. 
If,  for  example,  the  quantity-  of  money  is  doubled,  and  its 
velocity  of  circulation  is  halved,  while  the  quantity  of.  goods 
exchanged  remains  constant,  the  price  level  wall  be  undis- 
turbed. Likewise,  it  will  be  undisturbed  if  the  quantity  of 
money  is  doubled  and  the  quantity  of  goods  is  doubled,  while 
the  velocity  of  circulation  remains  the  same.  To  double  the 
quantity  of  money,  therefore,  is  not  always  to  double  prices. 
We  must  distinctly  recognize  that  the  quantity  of  money  is 
only  one  of  three  factors,  all  equally  important  in  determining 
the  price  level.  .  .  . 

We  now  come  to  the  strict  algebraic  statement  of  the  equa- 
tion of  exchange.  .  .  .  Let  us  denote  the  total  circulation,  of 
money,  i.  e.,  the  amount  of  money  expended  for  goods  in  a 
given  community  during  a  given  year,  by  E  (expenditure)  ; 
and  the  average  amount  of  money  in  circulation  in  the  com- 
munity during  the  year  by  M  (money).  M  will  be  the  simple 
arithmetical  average  of  the  amounts  of  money  existing  at  suc- 
cessive instants  separated  from  each  other  by  equal  intervals 
of  time  indefinitely  small.  If  we  divide  the  year's  expendi- 
tures, E,  by  the  average  amount  of  money,  M,  we  shall  obtain 

what  is  called  the  average  rate  of  turnover  of  money  in  its 
p 

exchange  for  goods,  jj     that  is,  the  velocity  of  circulation 

E 

of  money.     This  velocity  may  be  denoted  by  V,  so  that    -^ 

V;  then  E  may  be  expressed  as  MV .  In  words:  the  total 
circulation  of  money  in  the  sense  of  money  expended  is  equal 
to  the  total  money  in  circulation  multiplied  by  its  velocity  of 
circulation  or  turnover.  E  or  MV,  therefore,  expresses  the 
money  side  of  the  equation  of  exchange.  Turning  to  the 
goods  side  of  the  equation,  we  have  to  deal  with  the  prices  of 
goods  exchanged  and  quantities  of  goods  exchanged.  The 


IRVING  FISHER  165 

average  price  of  sale  of  any  particular  good,  such  as  bread, 
purchased  in  the  given  community  during  the  given  year,  may 
be  represented  by  p  (price)  ;  and  the  total  quantity  of  it  pur- 
chased, by  Q  (quantity)  ;  likewise  the  average  price  of  another 
good  (say  coal)  may  be  represented  by  p'  and  the  total  quan- 
tity of  it  exchanged,  by  Q'  ;  the  average  price  and  the  total 
quantity  of  a  third  good  (say  cloth)  may  be  represented  by 
p"  and  Q"  respectively;  and  so  on,  for  all  other  goods  ex- 
changed, however  numerous.  The  equation  of  exchange  may 
evidently  be  expressed  as  follows  : 


+P'Q' 

+P"Q" 

-fete, 

The  right-hand  side  of  this  equation  is  the  sum  of  terms 
of  the  form  pQ  —  a  price  multiplied  by  a  quantity  bought. 
It  is  customary  in  mathematics  to  abbreviate  such  a  sum  of 
terms  (all  of  which  are  of  the  same  form)  by  using  "2" 
as  a  symbol  of  summation.  This  symbol  does  not  signify  a 
magnitude  as  do  the  symbols  M,  V,  p,  Q,  etc.  It  signifies 
merely  the  operation  of  addition  and  should  be  read  "  the 
sum  of  terms  of  the  following  type."  The  equation  of  ex- 
change may  therefore  be  written  : 


That  is,  the  magnitudes  E,  M,  V,  the  p's  and  the  Q's  relate 
to  the  entire  community  and  an  entire  year;  but  they  are 
based  on  and  related  to  corresponding  magnitudes  for  the  in- 
dividual persons  of  which  the  community  is  composed  and 
for  the  individual  moments  of  time  of  which  the  year  is  com- 
posed. 

The  algebraic  derivation  of  this  equation  is,  of  course,  es- 
sentially the  same  as  the  arithmetical  derivation  previously 
given.  It  consists  simply  in  adding  together  the  equations 
for  all  individual  purchases  within  the  community  during  the 
year.  .  .  . 

[We  are  now]  .  .  .  prepared  for  the  inclusion  of  bank 
deposits  or  circulating  credit  in  the  equation  of  exchange.  We 


1 66  MONEY  AND  PRICES 

shall  still  use  M  to  express  the  quantity  of  actual  money,  and 
V  to  express  the  velocity  of  its  circulation.1  Similarly,  we 
shall  now  use  M'  to  express  the  total  deposits  subject  to 
transfer  by  check;  and  V  to  express  the  average  velocity  of 
circulation.  The  total  value  of  purchases  in  a  year  is  there- 
fore no  longer  to  be  measured  by  MV ,  but  by  MV  +  M'V. 
The  equation  of  exchange,  therefore,  becomes: 

MV  +  M'V'  =  ^pQ  =  PT2  .  .  . 

With  the  extension  of  the  equation  of  monetary  circulation 
to  include  deposit  circulation,  the  influence  exerted  by  the 
quantity  of  money  on  general  prices  becomes  less  direct;  and 
the  process  of  tracing  this  influence  becomes  more  difficult  and 
complicated.  It  has  even  been  argued  that  this  interposition 
of  circulating  credit  breaks  "whatever  connection  there  may  be 
between  prices  and  the  quantity  of  money.3  This  would  be 
true  if  circulating  credit  were  independent  of  money.  But 
the  fact  is  that  the  quantity  of  circulating  credit,  M',  tends 
to  hold  a  definite  relation  to  M,  the  quantity  of  money  in  cir- 
culation ;  that  is,  deposits  are  normally  a  more  or  less  definite 
multiple  of  money. 

Two  facts  normally  give  deposits  a  more  or  less  definite 
ratio  to  money.  The  first  ...  [is]  that  bank  reserves  are 
kept  in  a  more  or  less  definite  ratio  to  bank  deposits.  The 
second  is  that  individuals,  firms,  and  corporations  preserve 
more  or  less  definite  ratios  between  their  cash  transactions  and 
their  check  transactions,  and  also  between  their  money  and 
deposit  balances.4  These  ratios  are  determined  by  motives  of 
individual  convenience  and  habit.  In  general,  business  firms 

1  fFor  a  method  of  determining  the  velocity  of  the  circulation  of  money, 
see  Appendix  A.] 

2  It  is  important  to  bear  in  mind  that  wherever  P  is  used  in  this  chapter 
it  represents  the  index  number,  or  scale  of  prices,  at  which  the  trade, 
T,  is  conducted. —  EDITOR. 

3  An  almost  opposite  view  is  that  of  Laughlin  that  normal  credit  can- 
not affect  prices  because  it  is  not  an  offer  of  standard  money  and  cannot 
affect  the  value  of  the  standard  which  alone  determines  general  prices. 
See  the  Principles  of  Money,  New  York   (Scribner),  1903,  p.  97.     Both 
views  are  inconsistent  with  that  upheld  .  .  .  [here]. 

*  This  fact  is  apparently  overlooked  by  Laughlin  when  he  argues  that 
there  is  not  "any  reason  for  limiting  the  amount  of  the  deposit  currency, 
or  the  assumption  of  an  absolute  scarcity  of  specie  reserves."  See  Prin- 
ciples of  Money,  p.  127. 


IRVING  FISHER  167 

use  money  for  wage  payments,  and  for  small  miscellaneous 
transactions  included  under  the  term  "  petty  cash  " ;  while  for 
settlements  with  each  other  they  usually  prefer  checks.  These 
preferences  are  so  strong  that  we  could  not  imagine  them  over- 
ridden except  temporarily  and  to  a  small  degree.  A  business 
firm  would  hardly  pay  car  fares  with  checks  and  liquidate  its 
large  liabilities  with  cash.  Each  person  strikes  an  equilibrium 
between  his  use  of  the  two  methods  of  payment,  and  does  not 
greatly  disturb  it  except  for  short  periods  of  time.  He  keeps 
his  stock  of  money  or  his  bank  balance  in  constant  adjustment 
to  the  payments  he  makes  in  money  or  by  check.  Whenever 
his  stock  of  money  becomes  relatively  small  and  his  bank 
balance  relatively  large,  he  cashes  a  check.  In  the  opposite 
event,  he  deposits  cash.  In  this  way  he  is  constantly  convert- 
ing one  of  the  two  media  of  exchange  into  the  other.  A 
private  individual  usually  feeds  his  purse  from  his  bank  ac- 
count ;  a  retail  commercial  firm  usually  feeds  its  bank  account 
from  its  till.  The  bank  acts  as  intermediary  for  both. 

In  a  given  community  the  quantitative  relation  of  deposit 
currency  to  money  is  determined  by  several  considerations  of 
convenience.  In  the  first  place,  the  more  highly  developed 
the  business  of  a  community,  the  more  prevalent  the  use  of 
checks.  Where  business  is  conducted  on  a  large  scale,  mer- 
chants habitually  transact  their  larger  operations  with  each 
other  by  means  of  checks,  and  their  smaller  ones  by  means  of 
cash.  Again,  the  more  concentrated  the  population,  the  more 
prevalent  the  use  of  checks.  In  cities  it  is  more  convenient 
both  for  the  payer  and  the  payee  to  make  large  payments  by 
check;  whereas,  in  the  country,  trips  to  a  bank  are  too  ex- 
pensive in  time  and  effort  to  be  convenient,  and  therefore  more 
money  is  used  in  proportion  to  the  amount  of  business  done. 
Again,  the  wealthier  the  members  of  the  community,  the  more 
largely  will  they  use  checks.  Laborers  seldom  use  them;  but 
capitalists,  professional  and  salaried  men  use  them  habitually, 
for  personal  as  well  as  business  transactions. 

There  is,  then,  a  relation  of  convenience  and  custom  be- 
tween check  and  cash  circulation,  and  a  more  or  less  stable 
ratio  between  the  deposit  balance  of  the  average  man  or  corpo- 
ration and  the  stock  of  money  kept  in  pocket  or  till.  This 


168  MONEY  AND  PRICES 

fact,  as  applied  to  the  country  as  a  whole,  means  that  by  con- 
venience a  rough  ratio  is  fixed  between  M  and  M'.  If  that 
ratio  is  disturbed  temporarily,  there  will  come  into  play  a 
tendency  to  restore  it.  Individuals  will  deposit  surplus  cash, 
or  they  will  cash  surplus  deposits. 

Hence,  both  money  in  circulation  .  .  .  and  money  in  re- 
serve .  .  .  tend  to  keep  in  a  fixed  ratio  to  deposits.  It  fol- 
lows that  the  two  must  be  in  a  fixed  ratio  to  each  other. 

It  further  follows  that  any  change  in  M,  the  quantity  of 
money  in  circulation,  requiring  as  it  normally  does  a  pro- 
portional change  in  M',  the  volume  of  bank  deposits  subject 
to  check,  will  result  in  an  exactly  proportional  change  in  the 
general  level  of  prices  except,  of  course,  so  far  as  this  effect 
be  interfered  with  by  concomitant  changes  in  the  F's  or  the 
Q's.  The  truth  of  this  proposition  is  evident  -from  the  equa- 
tion MV  +  M'V  =  2/>Q;  for  if,  say,  M  and  M'  are  doubled, 
while  V  and  V  remain  the  same,  the  left  side  of  the  equation 
is  doubled  and  therefore  the  right  side  must  be  doubled  also. 
But  if  the  Q's  remain  unchanged,  then  evidently  all  the  p's 
must  be  doubled,  or  else  if  some  are  less  than  doubled,  others 
must  be  enough  more  than  doubled  to  compensate.  .  .  . 

The  factors  in  the  equation  of  exchange  are  .  .  .  con- 
tinually seeking  normal  adjustment.  A  ship  in  a  calm  sea 
will  "pitch"  only  a  few  times  before  coming  to  rest,  but  in 
a  high  sea,  the  pitching  never  ceases.  While  continually  seek- 
ing equilibrium,  the  ship  continually  encounters  causes  which 
accentuate  the  oscillation.  The  factors  seeking  mutual  ad- 
justment are  money  in  circulation,  deposits,  their  velocities, 
the  Q's  and  the  p's.  These  magnitudes  must  always  be  linked 
together  by  the  equation  MF  +  M'V'  =  2  pQ.  This  repre- 


sents the  mechanism  of  exchange.  But  in  order  to  conform 
to  such  a  relation  the  displacement  of  any  one  part  of  the 
mechanism  spreads  its  effects  during  the  transition  periods 
{i.e.,  periods  of  rising  or  falling  prices]  over  all  parts.  Since 
periods  of  transition  are  the  rule  and  those  of  equilibrium  the 
exception,  the  mechanism  of  exchange  is  almost  always  in  a 
dynamic  rather  than  a  static  condition.  .  .  .* 

1  Interesting  changes  in  the  magnitudes  of  the  equation   of  exchange 
between  1896  and  1914  are  given  in  the  appended  diagram,  which  is  taken 


IRVING  FISHER 


169 


0      (0      N      CO      G      O      —      OJlO 

ooooo    —    -    —    — 


MONEY  AND  PRICES 

1  It  is  interesting  to  make  a  quantitative  comparison  of  the 
various  magnitudes  with  the  increase  in  the  quantity  of  money 
as  the  most  important  factor  in  raising  the  price  level.  While 
it  is  true,  as  shown  by  the  diagram,  that  the  volume  of  de- 
posits subject  to  check  has  increased  greatly,  the  major  part 
of  the  increase  has  to  be  ascribed  to  the  increase  in  the  quantity 
of  money.  Only  so  far  as  the  volume  of  deposits  subject  to 
check  has  increased  relatively  to  the  money  in  circulation,  can 
the  increase  of  deposits  be  regarded  as  an  independent  cause 
of  the  rise  in  prices.  We  have  thus  to  consider  the  relative 
importance  of  the  five  causes  affecting  prices: 

1.  The  quantity  of  money  in  circulation  (M). 

2.  The  volume  of  bank  deposits  subject  to  check  considered 

relatively  to  money  (^~) 

3.  The  velocity  of  the  former  (V'J. 

4.  The  velocity  of  the  latter  (V). 

5.  The  volume  of  trade  (T). 

We  may  best  compare  the  relative  importance  of  these  five 
magnitudes  by  answering  the  question :  What  would  the  re- 
sult have  been  had  any  one  of  these  magnitudes  remained  un- 
changed, assuming  that  the  other  four  changed  in  the  same 
manner  that  they  actually  did  change.  We  find  (i)  that  if 
the  money  in  circulation,  M,  had  not  changed,  between  the 
years  1896  and  1909,  for  example,  the  price  level  of  1909 
would  have  been  45  per  cent,  lower  than  it  actually  wras;  (2) 

that  if  j^- ,  the  relative  deposits,  had  not  changed,  during  the 

same  period  the  price  level  in  1909  would  have  been  23  per 
cent,  lower  than  it  actually  was;  (3)  if  the  velocity  of  cir- 
culation of  money,  V,  had  not  changed,  the  price  level  for 
1909  would  have  been  I  per  cent  lower;  (4)  if  the  velocity 
of  circulation  of  deposits,  V,  had  not  changed,  the  price  level 
in  1909  would  have  been  28  per  cent,  lower;  (5)  if  T  had  not 

from  a  reprint  of  Professor  Fisher's  article,  The  Equation  of  Exchange 
for  1914,  and  the  War,  the  American  Economic  Review,  Vol.  V,  No.  2. 
June,  1915. —  EDITOR. 

1  Adapted  from  Irving  Fisher,  Recent  Changes  in  Price  Levels  and 
Their  Causes,  Bulletin  of  the  American  Economic  Association.  Fourth 
Series,  No.  2,  Papers  and  Discussions  of  the  Twenty-third  Annual  Meet- 
ing, December,  1910,  pp.  43-44. 


IRVING  FISHER  171 

changed,  the  price  level  in   1909  would  have  been   106  per 
cent,  higher. 

Thus  the  changes  in  the  first  four  factors  have  tended  to 
raise  prices,  while  the  change  in  T  has  tended  to  lower  prices. 
The  relative  importance  of  the  four  price-raising  causes  may 
be  stated  in  terms  of  the  per  cent,  already  given  which  repre- 
sents how  much  lower  prices  would  have  been  except  for  each 
of  these  causes  separately  considered.  According  to  this  test 
we  find  the  relative  importance  of  the  four  price-raising  factors 
to  be  as  follows: 

The  importance  of  V  is  represented  by  i, 
The  importance  of  ^-  is  represented  by  23, 
The  importance  of  V  is  represented  by  28, 
The  importance  of  M  is  represented  by  45. 

That  is,  the  increase  in  the  quantity  of  money  had  an  im- 
portance nearly  double  that  of  any  other  one  price-raising 
factor,  during  the  period  mentioned. 

INDIRECT  INFLUENCES  ON  PURCHASING  POWER  1 

Thus  far  we  have  considered  the  level  of  prices  as  affected 
by  the  volume  of  trade,  by  the  velocities  of  circulation  of 
money  and  of  deposits,  and  by  the  quantities  of  money 
and  of  deposits.  These  are  the  only  influences  which 
can  directly  affect  the  level  of  prices.  Any  other  influences 
on  prices  must  act  through  these  five.  There  are  myriads 
of  such  influences  (outside  of  the  equation  of  exchange)  that 
affect  prices  through  these  five.  It  is  our  purpose  ...  to 
note  the  chief  among  them.  .  .  . 

We  shall  first  consider  the  outside  influences  that  affect  the 
volume  of  trade  and,  through  it,  the  price  level.  The  condi- 
tions which  determine  the  extent  of  trade  are  numerous  and 
technical.  The  most  important  may  be  classified  as  follows: 

i.  Conditions  affecting  producers. 

(a)  Geographical  differences  in  natural  resources. 

(b)  The  division  of  labor. 

1  Irving  Fisher,  The  Purchasing  Power  of  Money,  pp.  74-88. 


172  MONEY  AND  PRICES 

(c)  Knowledge  of  the  technique  of  production. 

(d)  The  accumulation  of  capital. 

2.  Conditions  affecting  consumers. 

(a)   The  extent  and  variety  of  human  wants. 

3.  Conditions  connecting  producers  and  consumers. 

(a)  Facilities  for  transportation. 

(b)  Relative  freedom  of  trade. 

(c)  Character  of  monetary  and  banking  systems. 

(d)  Business  confidence. 

i  (a).  It  is  evident  that  if  all  localities  were  exactly  alike 
in  their  natural  resources,  in  other  words,  in  their  comparative 
costs  of  production,  no  trade  would  be  set  up  between 
them.  .  .  .  Cattle  raising  in  Texas,  the  production  of  coal  in 
Pennsylvania,  of  oranges  in  Florida,  and  of  apples  in  Oregon 
have  increased  the  volume  of  trade  for  these  communities 
respectively. 

I  (b).  Equally  obvious  is  the  influence  of  the  division  of 
labor.  .  .  . 

I  (c).  .  .  .  The  state  of  knowledge  of  production  will  af- 
fect trade.  Vast  coal  fields  in  China  await  development, 
largely  for  lack  of  knowledge  of  how  to  extract  and  market 
the  coal.  Egypt  awaits  the  advent  of  scientific  agriculture, 
to  usher  in  trade  expansion.  Nowadays,  trade  schools  in 
Germany,  England,  and  the  United  States  are  increasing  and 
diffusing  knowledge  of  productive  technique. 

I  (d).  But  knowledge,  to  be  of  use,  must  be  applied;  and 
its  application  usually  requires  the  aid  of  capital.  The  greater 
and  the  more  productive  the  stock  or  capital  in  any  com- 
munity, the  more  goods  it  can  put  into  the  currents  of 
trade.  .  .  . 

Since  increase  in  trade  tends  to  decrease  the  general  level 
of  prices,  anything  which  tends  to  increase  trade  likewise  tends 
to  decrease  the  general  level  of  prices.  We  conclude,  there- 
fore, that  among  the  causes  tending  to  decrease  prices  are  in- 
creasing geographical  or  personal  specialization,  improved 
productive  technique,  and  the  accumulation  of  capital.  The 
history  of  commerce  shows  that  all  these  causes  have  been  in- 


IRVING  FISHER  173 

creasingly  operative  during  a  long,  period  including  the  last 
century.  Consequently,  there  has  been  a  constant  tendency, 
from  these  sources  at  least,  for  prices  to  fall. 

2  (a).  .  .  .  An  increase  of  wants,  by  leading  to  an  in- 
crease in  trade,  tends  to  lower  the  price  level.     Historically, 
during  recent  times  through   invention,   education,   and  the 
emulation  coming  from  increased  contact  in  centers  of  popula- 
tion, there  has  been  a  great  intensification  and  diversification 
of  human  wants  and  therefore  increased  trade.     Consequently, 
there  has  been  from  these  causes  a  tendency  of  prices  to  fall. 

3  (a).  Anything  which  facilitates  intercourse  tends  to  in- 
crease trade.     Anything  that  interferes  with  intercourse  tends 
to  decrease  trade.     First  of  all,  there  are  the  mechanical  facili- 
ties for  transport     As  Macaulay  said,  with  the  exception  of 
the  alphabet  and  the  printing  press,  no  set  of  inventions  has 
tended  to  alter  civilization  so  much  as  those  which  abridge 
distance, —  such  as  the  railway,  the  steamship,  the  telephone, 
the  telegraph,  and  that  conveyer  of  information  and  advertise- 
ments, the  newspaper.     These  all  tend,  therefore,  to  decrease 
prices. 

3  (b).  Trade  barriers  are  not  only  physical  but  legal.  A 
tariff  between  countries  has  the  same  influence  in  decreasing 
trade  as  a  chain  of  mountains.  The  freer  the  trade,  the  more 
of  it  there  will  be.  ... 

3  (c).  The  development  of  efficient  monetary  and  banking 
systems  tends  to  increase  trade.  There  have  been  times  in 
the  history  of  the  world  when  money  was  in  so  uncertain  a 
state  that  people  hesitated  to  make  many  trade  contracts  be- 
cause of  the  lack  of  knowledge  of  what  wpuld  be  required  of 
them  when  the  contract  should  be  fulfilled.  In  the  same  way, 
when  people  cannot  depend  on  the  good  faith  or  stability  of 
banks,  they  will  hesitate  to  use  deposits  and  checks. 

3  (d).  Confidence,  not  only  in  banks  in  particular,  but  in 
business  in  general,  is  truly  said  to  be  "  the  soul  of  trade." 
Without  this  confidence  there  cannot  be  a  great  volume  of 
contracts.  Anything  that  tends  to  increase  this  confidence 
tends  to  increase  trade.  .  .  . 

We  see,  then,  that  prices  will  tend  to  fall  through  increase 
in  trade,  which  may  in  turn  be  brought  about  by  improved 


174  MONEY  AND  PRICES 

transportation,  by  increased  freedom  of  trade,  by  improve J 
monetary  and  banking  systems,  and  by  business  confidence. 
Historically,  during  recent  years,  all  of  these  causes  have 
tended  to  grow  in  power,  except  freedom  of  trade.  .  .  . 

Having  examined  those  causes  outside  the  equation  which 
affect  the  volume  of  trade,  our  next  task  is  to  consider  the 
outside  causes  that  affect  the  velocities  of  circulation  of  money 
and  of  deposits.  For  the  most  part,  the  causes  affecting  one 
of  these  velocities  affect  the  other  also.  These  causes  may  be 
classified  as  follows : 

1.  Habits  of  the  individual. 

(a)  As  to  thrift  and  hoarding. 

(b)  As  to  book  credit. 

(c)  As  to  the  use  of  checks. 

2.  Systems  of  payments  in  the  community. 

(a)  As  to  frequency  of  receipts  and  of  disbursements. 

(b)  As  to  regularity  of  receipts  and  disbursements. 

(c)  As  to  correspondence  between  times  and  amounts 
of  receipts  and  disbursements. 

3.  General  causes. 

(a)  Density  of  population. 

(b)  Rapidity  of  transportation. 

i  (a).  Taking  these  up  in  order,  we  may  first  consider 
what  influence  thrift  has  on  the  velocity  of  circulation. 
Velocity  of  circulation  of  money  is  the  same  thing  as  its  rate 
of  turnover.  It  is  found  by  dividing  the  total  payments  ef- 
fected by  money  in  a  year  by  the  amount  of  money  in  cir- 
culation in  a  year.  It  depends  upon  the  rates  of  turnover 
of  the  individuals  who  compose  the  society.  This  velocity  of 
circulation  or  rapidity  of  turnover  of  money  is  the  greater 
for  each  individual  the  more  he  spends,  with  a  given  average 
amount  of  cash  on  hand ;  or  the  less  average  cash  he  keeps, 
with  a  given  yearly  expenditure.  .  .  . 

i  (b).  The  habit  of  "charging,"  i.e.,  using  book  credit, 
tends  to  increase  the  velocity  of  circulation  of  money,  because 
the  man  who  gets  things  "  charged  "  does  not  need  to  keep 


IRVING  FISHER  175 

on  hand  as  much  money  as  he  would  if  he  made  all  payments 
in  cash.  A  man  who  pays  cash  daily  needs  to  keep  cash  for 
daily  contingencies.  The  system  of  cash  payments,  unlike  the 
system  of  book  credit,  requires  that  money  shall  be  kept  on 
hand  in  advance  of  purchases.  Evidently,  if  money  must  be 
provided  in  advance,  it  must  be  provided  in  larger  quantities 
than  when  merely  required  to  liquidate  past  debts.  .  .  . 

But  we  have  seen  that  to  increase  the  rate  of  turnover  will 
tend  to  increase  the  price  level.  Therefore,  book  credit  tends 
to  increase  the  price  level.  ... 

1  (c).  The  habit  of  using  checks  rather  than  money  will 
also  affect  the  velocity  of  circulation ;  because  a  depositor's 
surplus  money  will  immediately  be  put  into  the  bank  in  return 
for  a  right  to  draw  by  check.  .  .  . 

We  see,  then,  that  three  habits  —  spendthrift  habits,  the 
habit  of  charging,  and  the  habit  of  using  checks  —  all  tend 
to  raise  the  level  of  prices.  .  .  . 

2  (a).  The  more  frequently  money  or  checks  are  received 
and  disbursed,  the  shorter  is  the  average  interval  between  the 
receipt  and  the  expenditure  of  money  or  checks  and  the  more 
rapid  is  the  velocity  of  circulation. 

This  may  best  be  seen  from  an  example.  A  change  from 
monthly  to  weekly  wage  payments  tends  to  increase  the 
velocity  of  circulation  of  money.  If  a  laborer  is  paid  weekly 
$7  and  reduces  this  evenly  each  day,  ending  each  week  empty- 
handed,  his  average  cash  .  .  .  would  be  a  little  over  half  of 
$7,  or  about  $4.  This  makes  his  turnover  nearly  twice  a  week. 
Under  monthly  payments  the  laborer  who  receives  and  spends 
an  average  of  $i  a  day  will  have  to  spread  the  $30  more  or 
less  evenly  over  the  following  30  days.  If,  at  the  next  pay 
day,  he  comes  out  empty-handed,  his  average  money  during 
the  month  has  been  about  $15.  This  makes  his  turnover  about 
twice  a  month.  Thus  the  rate  of  turnover  is  more  rapid  under 
weekly  than  under  monthly  payments.  .  .  . 

Frequency  of  disbursements  evidently  has  an  effect  similar 
to  the  effect  of  frequency  of  receipts ;  i.  e.,  it  tends  to  ac- 
celerate the  velocity  of  turnover,  or  circulation. 

2  (b).  Regularity  of  payments  also  facilitates  the  turnover. 
When  the  workingman  can  be  fairly  certain  of  both  his  re- 


176  MONEY  AND  PRICES 

ceipts  and  expenditures,  he  can,  by  close  calculation,  adjust 
them  so  precisely  as  safely  to  end  each  payment  cycle  with  an 
empty  pocket.  This  habit  is  extremely  common  among  cer- 
tain classes  of  city  laborers.  On  the  other  hand,  if  the  re- 
ceipts and  expenditures  are  irregular,  either  in  amount  or  in 
time,  prudence  requires  the  worker  to  keep  a  larger  sum  on 
hand,  to  insure  against  mishaps.  .  .  .  We  may,  therefore,  con- 
clude that  regularity,  both  of  receipts  and  of  payments,  tends 
to  increase  velocity  of  circulation. 

2  (c).  Next,  consider  the  synchronizing  of  receipts  and  dis- 
bursements, i.  e.,  making  payments  at  the  same  intervals  as 
obtaining  receipts.  .  .  .  This  arrangement  obviates  the  neces- 
sity of  keeping  much  money  or  deposits  on  hand,  and  there- 
fore increases  their  velocity  of  circulation.  .  .  . 

3  (a).  The  more  densely  populated  a  locality,  the  more 
rapid  will  be  the  velocity  of  circulation. 

There  is  definite  evidence  that  this  is  true  of  bank  deposits. 
The  following  figures  give  the  velocities  of  circulation  of  de- 
posits in  ten  cities,  arranged  in  order  of  size: 


Paris 

116 

Lisbon               29 

Berlin 

161 

Indianapolis      30 

Brussels 

123 

New  Haven      16 

Madrid 

14 

Athens                4 

Rome 

43 

Santa  Barbara     i 

Madrid  is  the  only  city  seriously  out  of  its  order  in  respect 
to  velocity  of  circulation. 

3  (b).  Again  the  more  extensive  and  the  speedier  the 
transportation  in  general,  the  more  rapid  the  circulation  of 
money.  Anything  which  makes  it  easier  to  pass  money  from 
one  person  to  another  will  tend  to  increase  the  velocity  of 
circulation.  Railways  have  this  effect.  .  .  .  Mail  and  ex- 
press, by  facilitating  the  transmission  of  bank  deposits  and 
money,  have  likewise  tended  to  increase  their  velocity  of  cir- 
culation. 

We  conclude,  then,  that  density  of  population  and  rapidity 
of  transportation  have  tended  to  increase  prices  by  increasing 
velocities.  Historically  this  concentration  of  population  in 
cities  has  been  an  important  factor  in  raising  prices  in  the 
United  States. 


IRVING  FISHER  177 

[SUMMARY] 

1  The  purchasing  power  ...  of  money  has  been  studied  as 
the  effect  of  five,  and  only  five,  groups  of  causes.  The  five 
groups  are  money,  deposits,  their  velocities  of  circulation,  and 
the  volume  of  trade.  These  and  their  effects,  prices,  we  saw 
to  be  connected  by  an  equation  called  the  equation  of  ex- 
change, M7  -f  M'V  =  2  />Q.  The  five  causes,  in  turn,  .  .  . 
are  themselves  effects  of  antecedent  causes  lying  entirely  out- 
side of  the  equation  of  exchange,  as  follows:  the  volume  of 
trade  will  be  increased,  and  therefore  the  price  level  cor- 
respondingly decreased  by  the  differentiation  of  human  wants ; 
by  diversification  of  industry ;  and  by  facilitation  of  transpor- 
tation. The  velocities  of  circulation  will  be  increased,  and 
therefore  also  the  price  level  increased  by  improvident  habits; 
by  the  use  of  book  credit;  and  by  rapid  transportation.  The 
quantity  of  money  will  be  increased  and  therefore  the  price 
level  increased  correspondingly  by  the  import  and  minting  of 
money,  and,  antecedently,  by  the  mining  of  the  money  metal ; 
by  the  introduction  of  another  and  initially  cheaper  money 
metal  through  bimetallism;  and  by  the  issue  of  bank  notes  and 
other  paper  money.  The  quantity  of  deposits  will  be  in- 
creased, and  therefore  the  price  level  increased  by  extension 
of  the  banking  system  and  by  the  use  of  book  credit.  The 
reverse  causes  produce,  of  course,  reverse  effects. 

Thus,  behind  the  five  sets  of  causes  which  alone  affect  the 
purchasing  power  of  money,  we  find  over  a  dozen  antecedent 
causes.  If  we  chose  to  pursue  the  inquiry  to  still  remoter 
stages,  the  number  of  causes  would  be  found  to  increase  at 
each  stage  in  much  the  same  way  as  the  number  of  one's  an- 
cestors increases  with  each  generation  into  the  past.  In  the 
last  analysis  myriads  of  factors  play  upon  the  purchasing 
power  of  money ;  but  it  would  be  neither  feasible  nor  profitable 
to  catalogue  them.  The  value  of  our  analysis  consists  rather 
in  simplifying  the  problem  by  setting  forth  clearly  the  five 
proximate  causes  through  which  all  others  whatsoever  must 
operate.  At  the  close  of  our  study,  as  at  the  beginning,  stands 
forth  the  equation  of  exchange  as  the  great  determinant  of  the 
purchasing  power  of  money. 

1  Ibid.,  pp.  149,  150. 


178  MONEY  AND  PRICES 

J.  Laurence  Laughlin  1 :  To  my  mind,  the  following  prop- 
ositions contain  the  essence  of  the  theory  of  prices.  ...  As 
every  one  will  appreciate,  only  general  statements,  without  any 
limiting  qualifications  to  speak  of,  can  be  given  in  so  small  a 
compass. 

1.  The  price  of  a  commodity  is  measured  by  the  quantity  of 
a  given  standard  for  which  it  will  exchange. 

2.  A  change  of  prices  may  be  due  to  changes  in  the  condi- 
tions affecting  the  supply  (thus  including  expenses  of  produc- 
tion) of  goods,  as  well  as  to  changes  in  the  demand  for  and 
supply  of  gold.     A  statistical  statement  of  a  change  of  price 
is  not  a  statement  of  the  cause  of  the  change. 

3.  Probably  there  is  not  so  much  difference  of  opinion  re- 
garding the  theory  of  prices  as  is  sometimes  supposed.     Other 
causes  being  supposed  constant,  an  increased  -supply  of  gold 
would  tend  to  raise  prices.     No  one  can  fail  to  see  that,  if 
by  "  money  "  is  meant  gold,  a  change  in  its  quantity  would, 
other  things  being  equal,  be  a  factor  affecting  prices.     An  in- 
creasing demand  for  gold,  however,  would  work  against  the 
effect  of  an  increasing  supply.     If  the  new  demand  offset  the 
new  supply,  then,  if  changes  of  prices  occurred,  their  cause 
must  be  sought  in  the  influences  touching  the  producing  and 
marketing  of  goods. 

4.  The  effective  demand  for  goods  (granting  their  utility) 
is  limited  by  the  buyer's  purchasing  power.     This  purchasing 
power  is  not  identical  with  the  quantity  of  the  media  of  ex- 
change in  circulation,  any  more  than  the  value  of  the  total 
exchangeable  wealth  of  the  community  is  identical  with  the 
value  of  the  total  money  in  circulation. 

5.  The  general  level  of  prices  is  not  independent  of  particu- 
lar prices;  since  there  can  be  no  such  thing  as  a  general  level, 
or  average,  of  prices  which  is  not  the  resultant  of  a  number 
of  particular  prices  each  arrived  at  by  individual  buyers  and 
sellers.     The  causes  of  price  changes  must  be  sought  in  the 
forces  settling  particular  prices.     This  does  not  exclude  the 

1  Causes  of  the  Changes  in  Prices  since  1896,  Bulletin  of  the  American 
Economic  Association,  Fourth  Series,  No.  2,  Papers  and  Discussions  of 
the  Twenty-third  Annual  Meeting,  December,  1910,  pp.  27-36. 


J.  LAURENCE  LAUGHLIN  179 

consideration  of  any  causes  affecting  the  value  of  the  standard 
in  which  the  prices  of  goods  are  expressed,  because  the  stand- 
ard is  itself  a  particular  commodity. 

6.  In  particular  cases,  competitive  prices  in  this  country  are 
arrived  at  by  the  higgling  of  the  market,  which  depends  on 
buyers'  and  sellers'  judgment  of  the  demand  and  supply  of  the 
commodity  (e.  g.,  wheat) ;  and,  when  the  price  is  fixed,  the 
credit  medium  by  which  the  commodity  is  passed  from  seller 
to  buyer  comes  easily  and  naturally  into  existence  and,  of 
course,   for  a  sum  exactly  equaling  the  price  agreed  upon, 
multiplied  by  the  number  of  units  of  goods.     Price-making 
generally  precedes  the  demand  upon  the  media  of  exchange, 
and  does  not  at  all  imply  any  necessary  demand  at  the  moment 
upon  the  standard  in  which  the  prices  are  expressed  (cf.  10). 

7.  The  offer  of  "  money  "  for  goods  is  only  a  resultant  of 
price-making  forces  previously  at  work,  and  does  not  measure 
the  demand  for  goods  (cf.  6).     That  is,  the  quantity  of  the 
actual  media  of  exchange  thus  brought  into  use  is  a  result 
and  not  a  cause  of  the  price-making  process.     The  supposed 
offer  of  money  has  no  money  as  its  basis,  but  is  only  the  offer 
of  a  purchasing  power,  previously  existing,  based  on  saleable 
goods,  which  at  the  moment  of  payment  appears  expressed  in 
terms  of  the  standard.     By  credit  devices  the  actual  transfer 
of  the  standard  is  reduced  to  an  inconsiderable  minimum.     In 
reality   (as  in  foreign  trade)    goods  are  exchanged  against 
goods. 

8.  The  effect  of  credit  on  prices  is  to  be  found  mainly  in 
banking  facilities  by  which  goods  are  coined  into  means  of 
payment,  so  that,  expressed  in  terms  of  the  standard  gold,  they 
may  be  exchanged  against  each  other.     Thus  credit  devices 
relieve  the  standard  to  an  incredibly  great  degree  from  the 
demand  for  the  use  of  gold  as  a  medium  of  exchange,  and  thus 
remove  a  demand,  as  trade  increases,  which  would  otherwise 
have  enormously  affected  the  value  of  gold.     Thus  the  effect 
of  credit  on  the  general  level  of  prices  in  considerable  periods 
of  time  is  shown  by  a  tendency  to  reduce  the  demand  on  the 
standard  gold,  and  hence  to  prevent  the  tendency  toward  falling 
prices. 


180  MONEY  AND  PRICES 

9.  A  general  proposition  is  that  banks  are  limited  in  making 
loans  by  the  possession  of  capital,  a  bank  of  large  capital  and 
deposits  being  able  to  make  large  loans,  a  bank  of  small  capital 
and  deposits,  small  loans.     A  second  proposition  is  that  the 
demand  for  legitimate  loans  varies  with  the  exchanges  of  goods 
and  collateral  and  the  opportunites  for  investment.     With  an 
increasing   activity   in   business,   however  —  either   sound   or 
speculative  —  the  expansion  of  loans  is  limited  by  the  resources 
of  the  bank.     Next,  a  bank  trying  to  carry  a  certain  amount 
of  loans,  must  hold  a  specified  proportion  of  reserves  to  demand 
liabilities  under  the  rule  of  banking  experience  or  law.     The 
amount  of  its  capital  and  the  funds  left  with  it  determine  the 
relative  size  of  its  loan  item;  and  the  sum  of  its  loans  and 
resultant  deposits  determine  the  amount  of  its  reserves.     The 
reserves  of  a  bank  are  thus  a  consequence  of  the  loan  opera- 
tions.    This  conclusion,  however,  as  it  affects  the  practical 
problem  of  the  present  day,  is  not,  in  my  opinion,  invalidated 
by  the  conceivable  cases  arising,  when  business  tends  to  outrun 
banking  facilities,  in  which  anything  that  makes  increasing  re- 
serves possible  would  increase  the  power  of  the  banks  to  lend. 
When  gold  becomes  increasingly  abundant,  the  banks  having 
large  resources  more  easily  get  the  gold  reserves  needed  for 
their  operations.     It  still  remains  true  that  the  fact  of  an  in- 
creased supply  of  gold  does  not  of  itself  increase  loans,  unless 
conditions  of  business  demand  an  increase  in  loans.     There- 
fore, the  expansion  of  business  is  not  a  necessary  consequence 
of  an  increasing  supply  of  gold,  any  more  than  an  expansion 
of  railway  traffic  is  the  necessary  consequence  of  an  increasing 
supply  of  cars.     If  increasing  goods  are  in  existence  to  be 
transported,  then,  of  course,  there  is  an  increasing  demand  for 
cars.     Likewise,  if  there  are  more  bank  resources  and  loans, 
there  is  an  increasing  demand  for  that  which  is  lawful  reserve; 
from  which  it  is  claimed  that  the  use  of  new  gold  in  bank 
reserves,  under  present  conditions,  is  not  the  significant  causal 
force  which  expands  business  and  raises  prices   (although  it 
may  be  contemporary  with  it). 

10.  The  problem  of  explaining  the  general  level  of  prices  is 
one  of  arriving  at  the  adjustment  between  two  terms  of  a 
ratio  (the  standard  on  the  one  side,  and  goods  on  the  other), 


J.  LAURENCE  LAUGHLIN  l8l 

each  of  which  is  influenced  by  supply  and  demand.  Gold  being 
one,  and  goods  being  many,  a  cause  working  on  gold  alone,  and 
important  enough  to  show  an  appreciable  effect,  might  explain 
a  general  movement  of  prices.  In  practical  operation,  how- 
ever, because  of  the  large  existing  stock  of  gold,  very  con- 
siderable additions  may  take  place  in  the  supply  of  gold  without 
materially  changing  the  world  value  of  gold  as  related  to  goods 
in  general.  Rapid  changes  of  prices  are  hence  more  likely  to 
be  due  to  influences  in  the  market  for  goods,  to  speculative 
changes  of  demand  for  goods,  or  to  psychological  forces  work- 
ing independently  of  facts.  .  .  . 

In  the  problem  of  discovering  the  causes  of  changes  in  the 
level  of  prices,  it  is  necessary  first  to  reach  a  conclusion  as  to 
those  causes  which  operate  on  the  gold  standard  in  which  our 
prices  are  expressed.  By  so  doing  we  may  locate  the  general 
level  —  so  far  as  the  standard  is  concerned  —  or  the  one  thing 
which  might  work  as  a  cause  common  to  all  goods.  The  rela- 
tion between  gold  and  goods  might  be  illustrated  by  the  familiar 
mechanical  illustration:  a  rod  balanced  on  a  fulcrum,  on  one 
end  of  which  works  the  forces  affecting  the  value  of  gold,  and 
on  the  other  end  the  forces  affecting  the  value  of  particular 
goods.  The  relation  between  goods  and  gold  being  a  ratio, 
as  one  end  of  the  rod  goes  up,  the  other  necessarily  goes  down. 

There  are,  as  we  all  know,  various  forces  at  work  to  produce 
the  resultant  price  level.  We  may  here  start  from  a  proposi- 
tion on  which  we  can  all  agree.  An  increase  in  the  quantity 
of  the  monetary  standard  in  the  world  —  such  as  gold  —  would 
tend,  other  things  being  equal,  to  lower  its  value  and  thus  raise 
prices.  In  trying  to  find  the  causes  in  the  price  level  at  any 
given  time  (as  in  1896-1909)  it  is  necessary,  therefore,  after 
stating  the  facts  as  to  the  increase  of  gold,  to  examine  into  the 
influence  of  "  the  other  things." 

To  begin,  we  may  take  up  the  demand  for  gold,  which,  of 
course,  is  both  monetary  and  non-monetary.  First  as  to  the 
non-monetary  uses,  such  as  abrasion,  shipwreck,  and  disappear- 
ance in  the  arts :  The  statistics  of  consumption  in  the  arts  are 
unsatisfactory;  at  the  best  they  are  only  estimates.  Although 
the  total  production  of  the  world,  1493-1850,  was  $3,158,000,- 
ooo,  there  is  no  evidence  as  to  the  available  stock  in  1850. 


1 82  MONEY  AND  PRICES 

My  belief  is  that  there  was  not  more  than  $2,000,000,000. * 
In  the  period  of  1851-1895,  the  production  was  $5,641,000,- 
ooo,  and  the  consumption  in  the  arts,  at  the  average  rate  of 
$50,000,000  a  year  requires  a  deduction  of  $2,250,000,000, 
which  leaves  $3,391,000,000.  The  arts  in  recent  years  are 
estimated  to  use  more  than  $ioo,ooo,ooo.2  In  the  period, 
1896-1905,  if  $1,000,000,000  be  deducted  from  the  production 
of  $2,899,000,000  we  have  $1,899,000,000.  Thus  the  total 
available  stock  in  1905  would  be  about  $7,690,000,000.  The 
production  of  the  last  four  years,  1906-1910,  is  about  $1,600,- 
000,000,  or,  less  the  consumption  in  the  arts,  about  $1,200,- 
000,000. 

The  monetary  demand  for  gold,  on  the  other  hand,  has 
shown  certain  definite  characteristics.  Whether  it  be  pre- 
judice, or  enlightened  business  judgment,  the  commercial  na- 
tions of  the  world  have  shown  a  persistent  and  continuing 
disposition  to  adopt  a  gold  monetary  system  as  soon  as  their 
own  means,  or  the  forthcoming  supply  of  gold,  has  made  it 
possible.  The  United  States  led  in  1853,  when  we  declined 
to  change  the  ratio  in  order  to  bring  silver  into  circulation 
-hen  only  gold  was  in  use.  From  1871—3,  Germany,  the 
countries  of  the  Latin  Union,  Austria-Hungary,  the  United 
States  (with  the  resumption  in  gold  in  1879),  and  India  (in 
1893),  in  response  to  the  preferences  of  the  commercial  world, 
placed  themselves  on  the  gold  standard  by  legal  enactments. 
The  demand  for  gold  all  through  this  period  was  based  upon 
considerations  independent  of  the  movement  of  prices.  For 
this  was  a  time  of  falling  prices  when  much  was  heard  of  the 
appreciation  of  gold  and  the  need  of  silver.  In  spite  of  this 
iendency  toward  falling  prices,  the  movement  toward  the  adop- 
tion of  gold  went  on.  ...  It  was  precisely  this  large  new 
supply  of  gold  which  enabled  the  commercial  nations  to  gratify 
their  desire  for  what  they  believed  was  a  more  stable  standard. 

As  we  enter  the  present  period  (1896—1909)  we  find  this 
momentum  towards  the  gold  standard  still  in  force ;  and  other 
countries  in  emulation  planned  to  put  themselves  on  an  equally 

1  There  is  a  possible  error  here  of  perhaps  $500,000,000. 

2  The  estimate  for  1908  is  $113,996,000.     Cf.  U.  S.  Report  of  Director  of 
Mint,  1909,  p   So. 


J.  LAURENCE  LAUGHLIN  183 

stable  standard  with  those  whose  means  had  permitted  an 
earlier  action  —  quite  irrespective  of  the  fact  that  this  last 
was  a  period  of  rising  prices,  while  the  former  was  one  of 
falling  prices.  In  this  period,  Russia,  Japan,  various  states 
in  South  America,  such  as  Peru,  Argentina,  and  Brazil,  and 
recently  Mexico,  have  emphasized  the  movement  away  from 
silver  to  gold.  Moreover,  as  backward  lands,  like  Turkey, 
parts  of  Asia,  Egypt,  and  various  districts  of  Africa,  have 
developed  their  resources  and  increased  their  trade,  they  have 
taken  on  gold  in  their  monetary  systems.  With  increasing 
trade  also  there  are  more  exchanges  of  goods;  hence,  even  in 
countries  (like  Great  Britain  and  the  United  States)  that  do 
not  use  gold  to  speak  of,  except  in  reserves,  there  are  increasing 
loans  and  deposits  and  thus  a  demand  for  more  gold  reserves. 
Consequently,  in  countries  long  ago  established  on  the  gold 
standard  there  will  be  a  steadily  increasing  demand  for  gold 
as  exchanges  expand.  We  find  thus  a  special  characteristic  of 
the  demand  for  gold  (certainly  not  existing  in  the  demand  for 
silver).  The  power  of  developing  countries  to  soak  up  new 
gold  is  as  marked  a  part  of  present  conditions  as  is  the  power 
of  a  porous  and  sandy  soil  to  soak  up  a  heavy  rainfall.  We 
must,  therefore,  take  full  account  of  the  noticeable  fact  that 
the  recent  demand  for  gold  seems  about  to  keep  pace  with  the 
new  supply;  that  a  shipment  of  gold  from  the  mines  to  London 
is  to-day  eagerly  competed  for,  not  only  by  European  coun- 
tries, but  by  Egypt,  India,  Turkey,  Argentina,  and  Brazil. 

Consequently  it  may  be  of  interest  to  see  which  countries 
have  taken  the  largest  amounts  of  gold  into  their  stocks  since 
1895: 

United   States    $994,000,000 

Russia 427,000,000 

Germany    419,000,000 

South  American  States  213,000,000 

British   Empire    194,000,000 

Austria-Hungary    163,000,000 

Italy    160,000,000 

Besides  the  demand  for  gold  in  the  arts,  and  the  apparent 
monetary  demand,  as  thus  already  presented,  we  must  not  omit 
to  take  into  account  also  the  large  stocks  of  gold  held  by 
banks  and  institutions  which  publish  no  statements.  In  the 


1 84  MONEY  AND  PRICES 

hands  of  large  private  institutions  like  those  of  the  Rothschilds, 
Bleichroders,  and  others,  great  amounts  of  gold  are  carried. 
It  is  from  such  stores  that  the  needs  of  states,  such  as  Austria- 
Hungary,  France,  Italy,  and  even  the  United  States  (in  Cleve- 
land's administration),  have  been  supplied  without  drawing 
down  visible  reserves. 

Thus  far,  then,  we  have  examined  the  one  factor  of  demand 
for  gold,  among  the  "  other  things  "  (which  were  supposed  to 
remain  equal).  There  is  abundant  evidence  to  show  that  the 
demand  for  gold,  in  this  recent  period  of  rising  prices  (1896— 
1909)  has  been  as  strong  as,  or  even  stronger  than,  the  de- 
mand for  gold  in  the  previous  period  (1873-1896)  of  falling 
prices. 

It  looks  very  much  as  if  we  must  seek  for  the  causes  of 
rising  prices  since  1896  in  some  of  the  "  other  things  "  not  yet 
examined.  There  is  no  time,  however,  for  extended  discussion 
on  these  points.  .  .  . 

The  effects  of  Tariffs  and  Taxation,  Unionism  and  higher 
Wages,  and  changing  Agricultural  Conditions  in  increasing 
expenses  of  production  in  all  industries  are  so  patent  as  to 
require  no  enlargement.  Immediately  after  the  passage  of  the 
Dingley  Act  in  1897,  a  large  list  of  articles  rose  in  price  pre- 
cipitously. Moreover,  just  so  far  as  higher  money  wages  for 
the  same  work,  or  the  same  money  wages  for  a  reduced  number 
of  hours,  have  been  granted  without  a  corresponding  increase 
in  the  efficiency  of  the  labor,  the  expenses  of  producing  goods 
in  general  —  and  consequently  prices  —  have  risen.  But, 
without  doubt,  one  of  the  most  important  factors  in  raising 
prices  —  directly  and  indirectly  —  has  been  the  increased  price 
of  food  due  to  the  changing  conditions  of  agriculture.  This 
most  influential  cause  of  higher  prices  is  one  of  the  "  other 
things  "  which  has  been  at  work  quite  independent  of  the  quan- 
tity of  new  gold.  Moreover,  the  indirect  effect  of  high  prices 
of  food  produces  the  most  serious  practical  problem.  It  wipes 
out  all  the  gain  of  previous  increases  of  wages,  and  drives 
laborers  to  repeat  their  demands  for  higher  pay,  thus  work- 
ing again  to  increase  expenses  of  production.  It  is  not  too 
much  to  say  that  the  gains  of  industry,  shown  by  the  fall  in 
prices,  as  they  stood  about  1890  have  been  lost  to  us  by  the 


J.  LAURENCE  LAUGHLIN  185 

high  tariffs  of  1897  and  the  wastes  of  bad  farming  and  the 
recent  high  costs  of  agriculture. 

Our  analysis  would  be  inadequate,  however,  if  we  stopped 
here  with  our  examination  of  expenses  of  production.  The 
really  practical  problem  is  still  before  us  in  trying  to  analyze 
the  forces  at  work  fixing  prices  in  that  vague  and  dangerous 
margin  between  actual  expenses  of  production  and  the  prices 
in  fact  paid  by  the  consumer.  .  .  . 

The  whole  raison  d'etre  of  monopolistic  combinations  is  to 
control  prices,  and  prevent  active  competition.  As  every  econ- 
omist knows,  in  the  conditions  under  which  many  industries 
are  to-day  organized,  expenses  of  production  have  no  direct 
relation  to  prices.  In  such  conditions,  there  is  a  field  in  which 
the  policy  of  charging  "what  the  traffic  will  bear"  prevails; 
and  this  includes  industries  that  are  not  public  utilities. 

Furthermore,  we  must  face  the  fact  of  increasing  riches  not 
only  in  this  country,  but  all  over  the  world.  New  wealth 
makes  a  liberal  spender.  The  retail  dealer  finding  his  ex- 
penses increasing  and  —  even  when  they  are  not  —  tries  the 
experiment  of  charging  his  richer  customers  an  increasing 
price.  The  newly  rich  pay  and  do  not  feel  it.  But  what  can 
the  poorer  unorganized  buyer  do  when  retail  prices  are  raised  ? 
What  can  he  do  if  his  meat  bill,  or  his  plumbing-repairs  bill, 
rises  enormously?  The  extravagance  of  the  rich  has  increased 
the  cost  of  traveling,  the  rates  at  hotels,  the  fees,  the  luxury 
of  steamships  and  automobiles,  the  consumption  of  fruits  and 
vegetables  out  of  season  once  never  thought  of,  and  has  gen- 
erally raised  the  standard  of  expenditure.  Those  of  smaller  in- 
come find  they  also  must  pay  the  higher  prices.  Thus  we  have 
reached  a  point  where  we  have  to  pay  almost  whatever  any  one 
asks.  Organized  buyers  are  the  only  offset  to  organized  sellers. 

Moreover,  rising  prices  due  to  high  expenses  of  production, 
or  to  combinations  of  sellers,  present  a  paradise  for  specula- 
tion. A  movement  upward  based  on  facts  can  be  easily  con- 
verted into  a  further  rise  based  only  on  speculative  manipula- 
tion. A  rise  of  prices  which  brings  large  profits  to  a  combina- 
tion, thus  directly  affects  earnings  and  gives  especial  opportun- 
ity to  speculation  in  the  securities  of  industrials.  Hence,  the 
field  of  speculation  spreads  from  commodities  to  securities. 


1 86  MONEY  AND  PRICES 

The  facts  as  to  the  movement  of  prices  of  securities  are  well 
shown  in  Brookmire's  Economic  Charts  since  1885 ;  and,  while 
the  presence  of  gold  serves  as  a  fund  of  lawful  money  in  re- 
serves, the  spread  of  speculation  has  gone  on  seemingly  un- 
affected by  the  new  supplies  of  gold.  That  is,  speculative  con- 
ditions may  arise  and  disappear  antecedent  to  and  seemingly 
independent  of  the  gold  supplies. 

D.  F.  Houston  1 :  The  discussion  of  money  and  prices  to- 
day reminds  one  very  strongly  of  the  discussion  forty  years 
ago.  Now,  as  then,  the  opinion  is  that  prices  have  risen;  but 
now,  as  then,  there  is  wade  difference  as  to  the  explanation. 
Now,  as  then,  a  highly  respectable  body  of  economists  attrib- 
ute the  rise  mainly  to  the  new  gold ;  and  now,  as  then,  a  num- 
ber of  economists  attribute  the  rise  to  influences  immediately 
affecting  the  cost  of  production  of  commodities  in  general, 
instancing  such  things  as  labor  unions,  monopolies,  extrav- 
agance, the  tariff,  general  prosperity,  etc.  .  .  . 

That  the  tariff  has  played  a  part  in  the  situation,  I  should 
of  course  not  deny.  By  preventing  us  from  securing  supplies 
where  they  can  be  more  economically  produced,  and  by  making 
it  possible  for  domestic  manufacturers  to  monopolize  the 
market,  and  by  tending  to  compel  the  payment  for  exports  in 
gold,  it  has  unquestionably  played  a  part  and  is  a  notable 
factor.  ...  In  considering  the  tariff  as  a  factor,  however,  we 
must  not  forget  that  we  have  had  the  tariff  since  the  beginning, 
and  that  the  rates  have  been  nearly  as  high  since  the  Civil 
War  as  they  are  to-day;  and  we  must  remember,  further,  that 
in  one  of  the  great  countries  which  has  no  protective  tariff 
the  tendency  of  price  has  been  upward;  furthermore,  wre  must 
not  overlook  the  fact  that  many  of  the  tariff  rates,  which  are 
very  high  now,  are  not  effective  or  not  nearly  so  effective  as 
they  were  in  the  earlier  period,  and  also  that  its  influence  is 
probably  greater  in  things  in  which  the  rise  of  price  has  been 
less  marked. 

I  should  not  deny  that  labor  unions  and  monopolies  have 
had  an  influence  in  increasing  price.  The  evidence  seems  to 
justify  the  conclusion  that  monopolies  have  had  some  effect 

1  Bulletin,  Am.  Econ.  Assoc.,  Fourth  Series,  No.  2,  1910,  pp.  46-52. 


D.  F.  HOUSTON  187 

in  increasing  price.  I  am  not  sure  that  there  is  sufficient  evi- 
dence in  regard  to  labor  unions  to  enable  us  to  form  a  con- 
clusion. .  .  . 

Much  has  been  said  in  discussion  about  the  influence  of  ex- 
travagance. This  has  played  a  part  in  similar  discussions  at 
all  times;  every  era  has  its  cry  of  extravagance,  and  it  is  not 
clear  that  it  has  been  more  marked  in  our  time  than  in  former 
times.  And  one  thing  is  quite  clear,  that  the  extravagance, 
or  economic  waste,  resulting  from  the  prosecution  of  war  and 
its  after  effects,  has  been  conspicuously  absent  during  the  last 
fifteen  years.  .  .  . 

The  stock  of  gold  in  the  leading  western  commercial  na- 
tions, with  which  we  are  concerned  in  discussing  prices,  prob- 
ably did  not  exceed  $5,000,000,000  at  the  end  of  1895.  During 
the  next  fourteen  years  there  was  added  to  the  stock  of  gold 
of  these  countries  an  amount  nearly  equal  to  the  existing  stock. 
In  addition,  a  number  of  these  countries  enormously  developed 
their  credit  devices.  According  to  all  economic  law,  these 
facts  create  a  strong  presumption  that  gold  has  been  the  main 
factor  affecting  price.  No  sufficient  evidence  has  been  pre- 
sented to  overthrow  this  presumption. 

E.  W.  Kemmerer  * :  An  adequate  discussion  of  the  papers 
presented  by  Professors  Fisher  and  Laughlin  would  require 
much  more  time  than  the  few  minutes  at  my  disposal.  I  shall 
accordingly  limit  myself  to  a  few  points  and  support  my  con- 
clusions principally  by  footnote  references.  This  procedure 
is  perhaps  the  more  justifiable  in  view  of  the  fact  that  my  own 
philosophy  of  the  relationship  between  money  and  prices  is 
given  in  detail  in  the  book  2  on  money  and  prices  to  which 
Professor  Fisher  has  so  generously  referred.3 

I  have  had  the  opportunity  of  reading  in  manuscript  Pro- 
fessor Fisher's  forthcoming  book  on  Price  Levels,  of  which 
his  paper  to-day  represents  one  chapter,  and  find  myself  in 
substantial  agreement  with  his  main  contentions.  His  discus- 
sion is  a  permanent  contribution  to  monetary  science  of  very 

1  Ibid.,  pp.  52-61. 

2  Money  and  Credit  Instruments  in  their  Relation  to  General  Prices,  2(1 
edition,  1909.     New  York:  Henry  Holt  &  Company. 

3  The  passages  referred  to  are  omitted. —  EDITOR. 


1 88  MONEY  AND  PRICES 

great  value.  To  a  number  of  minor  points,  however,  it  seems 
to  me,  exception  must  be  taken.  .  .  . 

Professor  Fisher's  formula  expressing  the  relationship  be- 
tween the  circulating  media  and  prices  is  essentially  the  same 
as  my  own,1  but  he  pays  little  attention  to  the  factor  of  busi- 
ness confidence,  which  is  a  most  important  consideration  in  the 
interpretation  of  the  formula.  The  ratio  of  deposit  currency 
to  bank  reserves  is  a  function  of  business  confidence.2 

The  distinction  Professor  Fisher  draws  between  the  prices 
of  individual  commodities  and  the  general  price  level  appears 
to  me,  as  to  Professor  Laughlin,  to  be  untenable.  It  is,  more- 
over, contradictory  to  his  general  philosophy  of  money.  His 
index  numbers  recognize  no  general  price  level  distinct  from 
individual  prices.  He  illustrates  the  point  that  the  price  of 
any  individual  commodity  presupposes  a  general  price  level  by 
saying  that  "  the  position  of  a  particular  wave  in  the  ocean 
depends  on  the  general  level  of  the  ocean."  I  can  conceive  of 
no  such  distinction  between  the  general  price  level  and  in- 
dividual prices  as  his  statements  seem  to  imply.  General  prices 
"  are  but  a  combination,  or  composite  photograph,  as  it  were, 
of  individual  prices."  .  .  .3 

Passing  to  Professor  Laughlin's  paper,  which  has  been  pre- 
sented to  me  merely  in  the  form  of  an  abstract,  we  find  ten 
propositions,  which  to  a  considerable  extent  are  repetitious. 
His  first  five  propositions  are  rather  commonplace  generaliza- 
tions and  few  economists  will  be  disposed  to  dissent  from  their 
essential  soundness.  They  place  him  much  closer  to  the  quan- 
tity theory  of  money  than  most  of  us,  judging  him  from  his 
previous  writings,  wrere  disposed  to  think  he  would  go ;  and  in 
his  third  proposition  he  says,  "  Probably  there  is  not  so  much 
difference  of  mind  regarding  the  theory  of  prices  as  is  some- 
times supposed." 

With  reference  to  Professor  Laughlin's  fourth  proposition 
it  may  be  said  that  no  economist  of  standing  claims  that  pur- 
chasing power  is  "  identical  with  the  quantity  of  the  media  of 
exchange  in  circulation."  Effective  purchasing  power,  how- 

1  Ketnmerer,  Money  and  Credit  Instruments,  pp.  9-18,  74-82. 

2  Ibid.,  pp.  82-8,  121-6,  145-8. 

8 Ibid.,  p.  9.     [See  Fisher:  Purchasing  Power  of  Money,  pp.  175-180.] 


E.  W.  KEMMERER  189 

ever,  in  our  modern  business  communities,  does  depend  upon 
the  possession  of  money  or  of  the  right  to  demand  money. 
The  amount  of  deposit  currency  which  can  be  used  at  any  time 
in  purchasing  goods  is  limited  by  bank  reserves  because  com- 
mercial deposits  are  payable  in  money  on  demand  at  the  order 
of  the  depositor.  Other  assets,  no  matter  how  good,  cannot 
be  used  for  the  purpose  of  meeting  deposit  obligations,  except 
when  the  entire  credit  machinery  breaks  down  and  suspension 
is  resorted  to  under  the  euphemistic  name  of  clearing  house 
loan  certificates. 

Professor  Laughlin's  sixth  and  seventh  points  are  essentially 
the  same  and  may  be  considered  together.  He  says : 

.  .  .  Price-making  generally  precedes  the  demand  upon  the 
media  of  exchange,  and  does  not  at  all  imply  any  necessary  de- 
mand at  the  moment  upon  the  standard  in  which  the  prices  are  ex- 
pressed. .  .  .  The  offer  of  money  for  goods  is  only  a  resultant  of 
price-making  forces  previously  at  work,  and  does  not  measure  the 
demand  for  goods.  .  .  .  That  is,  the  quantity  of  the  actual  media  of 
exchange  thus  brought  into  use  is  a  result  and  not  a  cause  of  the 
price-making  process.  .  .  . 

This  contention  appears  to  me  to  result  from  a  superficial  view 
of  the  price-making  process.  The  offer  of  money  for  goods 
and  the  offer  of  goods  for  money  are  of  course  not  the  first 
steps.  Each  person  has  his  own  individual  or  subjective  prices 
on  all  sorts  of  commodities;  these  subjective  prices  represent 
the  valuations  which  he  places  upon  the  respective  commodities 
in  terms  of  the  valuation  which  he  places  upon  the  money  unit. 
The  more  of  a  particular  commodity  he  has  the  lower  his  sub- 
jective valuation  of  a  unit  of  that  commodity ;  the  more  money 
he  owns  the  lower  his  estimation  of  a  dollar  and  the  higher  his 
subjective  prices;  and  vice  versa.  Through  a  process  of  com- 
petition, selection,  and  adaptation,  some  of  these  subjective 
prices  develop  into  market  prices,  that  is,  prices  at  which  both 
buyer  and  seller  benefit,  and  at  which  therefore  an  exchange 
takes  place.  To  paraphrase  an  old  adage,  .the  proof  of  the 
market  price  is  in  the  exchange.  It  is  a  common  observation 
that  stock  quotations  to  be  of  much  value  must  show  the  num- 
ber of  sales  effected  at  the  prices  quoted.  A  stock  for  which 
the  maximum  bids  were  100  and  the  minimum  offers  were  no, 


I9C  MONEY  AND  PRICES 

would  not  possess  a  market  price  in  the  strict  sense  of  the  word. 
The  fact  that  sales  have  recently  been  made  at  a  certain  price, 
or  are  now  being  so  made,  is  of  course  presumptive  evidence 
that  intending  purchasers  can  buy  at  about  that  price.  A 
market  price,  however,  is  the  amount  of  money  paid  for  a 
commodity,  not  the  amount  asked,  offered,  or  promised. 

Professor  Laughlin's  ninth  proposition  I  find  very  difficult 
to  follow.     His  premise  that  reserves  are  "  a  consequence  of 
the  loan  operations  "  is  a  dangerous  half  truth ;  they  are  also 
a  consequence  of  most  other  kinds  of  banking  operations,  cash 
deposits,  cash  withdrawals  and  clearing  house  balances,  foreign 
and  domestic  exchange  operations,  etc.     His  other  premise, 
that  "  the  fact  of  an  increased  supply  of  gold  does  not  of  itself 
[the  italics  are  mine]  increase  loans,  unless  the  bank  possesses 
the  control  of  the  capital  which  is  a  condition  precedent  to  the 
loans,"  contains  an  element  of  truth,  but  is  misleading.     While 
an  increased  supply  of  gold  does  not  of  itself  increase  loans  it 
normally  has  that  result ;  and  the  bank's  discount  rate  and  the 
condition  of  its  reserve  are  powerful  factors  in  influencing  its 
loan  account.     His  premises,  I  believe,  are  not  sound,  and  his 
conclusion,  namely,  that  "  the  expansion  of  business  is  not  a 
direct  consequence  of  an  increasing  supply  of  gold,  any  more 
than  an  expansion  of  railway  traffic  is  the  direct  consequence 
of  an  increasing  supply  of  cars,"  would  not  follow  from  his 
premises,  even  if  they  were  sound.     The  normal  causal  chain 
is  more  nearly  this :  increased  gold  production  results  in  greatly 
increased  amounts  of  gold  coming  into  the  monetary  uses.1 
This  gold  comes  into  the  hands  of  individuals  and  is  to  a  large 
extent  deposited  in  banks ;  increased  money  incomes  on  the 
part  of  individuals  lower  their  estimations  of  the  value  of  the 
money  unit,  raise  subjective  prices,  and  as  a  consequence  market 
prices ;  larger  money  deposits  in  banks  result  in  larger  reserves, 
banks  do  not  make  interest  on  money  held  in  reserves,  and 
accordingly  take  measures  to  invest  such  surplus  money,  keep- 
ing these  reserves  as  low  as  is  consistent  with  law  and  their 
ideas  of  safety;2  inducements  to  borrowers  are  made  in  the 

1  The  value  of  gold  bullion  deposited  at  the  United  States  mints  and 
assay  offices  increased  from  $87,924,000  for  1897  to  $205,036,000  for  1907. 
Figures  furnished  by  the  Director  of  the  Mint. 

2  It  is  noteworthy  that  the  reserves  of  the  New  York  associated  banks, 


E.  W.  KEMMERER  19! 

form  of  more  favorable  discount  rates ;  collateral  is  not  scruti- 
nized so  carefully;  the  speculative  market  is  stimulated  by  in- 
creasing supplies  of  call  money;  confidence  everywhere  in- 
creases ;  new  enterprises  spring  up  and  old  ones  are  expanded ; 
and  in  a  short  time  the  new  gold  is  absorbed  by  a  higher  price 
level  and  an  overstimulated  business  activity.  This  was  the 
situation  after  the  Californian  and  Australian  gold  discoveries 
of  the  last  century  and  it  has  been  the  result  of  the  greatly  in- 
creased gold  production  of  the  last  few  years. 

Professor  Laughlin's  final  point  is  that  since  1895  the  new 
demand  for  gold  has  roughly  equalled  the  new  supply,  and  that 
the  changes  in  prices  since  1896  must  be  sought  mainly  in  the 
"  other  things,"  which  have  not  remained  equal.  In  support 
of  this  conclusion  he  offers  two  principal  arguments.  The 
first  is  as  follows : 

.  .  .  Because  of  the  large  existing  stock  of  gold,  very  considerable 
changes  may  take  place  in  the  supply  of  gold  without  materially 
changing  the  world  value  of  gold  as  related  to  goods  in  general. 
Rapid  changes  of  price  are  hence  more  likely  to  be  due  to  influences 
in  the  market  for  goods,  to  speculative  changes  of  demand  for  goods, 
or  to  psychological  forces  working  independently  of  facts.  .  .  . 

In  reply  it  may  be  said  that  the  production  of  gold  since 
1895  represents  a  very  large  percentage  of  the  total  supply. 
The  Soetbeer  figures  as  supplemented  by  those  of  the  Director 
of  the  Mint  show  that  the  world's  gold  production  for  the  405 
years  1492-1896  inclusive  was  in  round  numbers  $8,982,000,- 
ooo,1  and  that  for  the  eleven  years  1897—1907,  was  $3,513,- 
000,000 ;  in  other  words,  for  these  eleven  years  it  was  over  39 
per  cent,  of  the  total  for  the  preceding  405  years.  Probably 
the  effective  supply  represents  a  much  larger  proportion  of 
recent  gold  because  of  ( i )  the  large  amount  of  loss  chiefly  by 
abrasion  of  the  gold  produced  in  the  earlier  years,  and  of  (2) 
the  greater  degree  to  which  this  early  gold  has  assumed  spe- 
cialized forms,  such  as  jewelry,  plate,  etc. 

Satisfactory  index  numbers  of  prices  for  recent  years  are 

for  example  are  usually  kept  very  close  to  the  legal  reserve  requirements. 
Cf.  Sprague.,  Crises  under  the  National  Banking  System,  p.  222. 

1  Gold  produced  before  1492  represents  an  insignificant  part  of  the  exist- 
ing  supply. 


192  MONEY  AND  PRICES 

not  available  for  all  the  principal  countries  of  the  world.  Such 
as  we  have,  however,  point  to  a  decided  rise  of  prices  in  all 
gold  standard  countries  since  about  1897.  Comparing  stand- 
ard price  index  numbers  in  six  of  the  chief  countries  of  the 
world  for  the  years  1897  an<l  I9°7>  we  &nd  the  general  price 
level  to  have  risen  as  follows : 1 

United  States  —  Bureau  of  Labor  figures  44-4% 

Canada  —  Coats  figures,   (weighted)    43-7% 

England  —  Sauerbeck  figures    29.0% 

France  —  de  Foville,  figures  for  export  prices  2 13-3% 

Germany  —  Hamburg  figures   30.8% 

Italy  —  Necco  figures  for  export  prices  23.4% 

If  we  average  these  figures  together,  assigning  the  same  im- 
portance to  the  figures  of  each  country,  in  order  to  get  a  rough 
idea  of  the  movement  of  world  prices  in  gold  standard  coun- 
tries during  the  eleven  years  in  question,  we  find  that  the 
average  increase  was  30.8  per  cent.  If  we  follow  Professor 
Laughlin  and  compare  the  years  1895  and  1907,  we  find  the 
average  increase  in  prices  to  have  been  25.8  per  cent.,  and  the 
world's  gold  production  for  the  13  years  1895  to  1907  to  have 
been  about  42  per  cent,  of  that  for  the  preceding  404  years. 
When  to  this  is  added  the  fact  that  the  evidence  points  to  a 
smaller  percentage  of  the  world's  annual  gold  production  going 
into  the  industrial  uses  than  formerly,  and  the  further  fact 
that  during  the  period  in  question  the  increase  and  improve- 
ments in  the  world's  banking  facilities  have,  greatly  economized 
the  uses  of  money,  we  see  that  a  very  substantial  increase  in 
general  prices  would  be  expected,  despite  a  great  expansion  of 
business.  World  prices  in  fact  have  not  increased  nearly  as 
rapidly  as  the  flow  of  gold  into  monetary  uses  since  1897,  not 
to  mention  the  enormous  development  of  deposit  currency. 
The  Director  of  the  Mint  estimates  each  year  the  amount  of 
the  world's  new  gold  used  in  the  industrial  arts.  Computa- 
tions I  have  made  based  upon  these  figures  show  a  tendency 
for  a  decreasing  percentage  of  the  annual  production  to  be 
used  in  the  arts,  although  th'ere  is  considerable  irregularity. 

1  Useful  tables  summarizing  all  of  these  index  numbers,  except  those  of 
Canada,  are  given  by  Achille  Necco,  in  his  article  on  La  ciirvct  dei  prczsi 
delle  mcrci  in  Italia  ncgli  anni  1881-1909,  in  La  Riforma  Socialc,  Sept.-Oct., 
1910. 

2  Comparison  is  for  1897  and  1906,  figures  for  1907  not  being  available. 


E.  W.  KEMMERER  193 

For  the  seven  years  1895—1901  the  average  percentage  was 
27.1,  and  for  the  seven  years  1902-1908  it  was  25. 3-1 

Professor  Laughlin's  second  argument  in  favor  of  the 
proposition  that  the  recent  rise  in  prices  has  not  been  due 
primarily  to  the  increased  gold  production  is  one  of  the  most 
beautiful  examples  of  begging  the  question  that  I  have  seen 
in  economic  literature.  He  says : 

"  In  recent  discussions  one  of  the  '  other '  factors  which  has  been 
slighted  is  the  demand  for  gold  since  1895.  The  examination  shows 
that  the  new  demand  in  countries  turning  to  the  gold  standard,  and  in 
those  already  using  gold  and  extending  their  demand,  amounts  in 
round  numbers  to  about  $3,000,000,000.  Hence  the  new  demand  has 
roughly  equalled  the  new  supply,  since  1895  —  a  fact  which  jumps 
with  the  known  conditions  in  the  great  financial  markets  like  London, 
where  new  arrivals  of  gold  are  eagerly  competed  for  by  European 
banks." 

Of  course  the  demand  for  gold  equals  the  supply,  as  does 
the  demand  for  wheat  or  any  other  commodity,  when  one  in- 
terprets demand  and  supply  as  one  should,  in  terms  of  market 
prices.  The  general  price  level  is  the  very  thing  which  equili- 
brates the  demand  for  gold  and  the  supply.  The  higher  price 
level  about  which  we  are  talking  is  an  expression  of  the  ab- 
sorption of  most  of  this  new  gold  into  the  world's  circulation. 
Banks  and  merchants  eagerly  compete  for  it,  because  higher 
prices  require  more  money  to  do  a  given  amount  of  exchange 
work,  and  rising  prices  stimulate  business. 

Joseph  French  Johnson  2  :  I  am  glad  to  observe  that  there 
appears  to  be  a  tendency  toward  agreement  with  regard  to 
the  fact  that  the  value  of  money  depends  upon  the  demand 
for  it  and  supply  of  it.  Professor  Laughlin  likes  the  word 
standard  better  than  I  do.  It  suggests  something  permanent 
and  fixed,  whereas  money  is  a  very  changeable  thing.  While 
I  am  in  agreement  with  Professor  Laughlin  in  the  conclusion 
that  the  general  level  of  prices  depends  upon  the  demand  for 
and  supply  of  money,  I  am  unable  to  give  assent  to  many  of 

1  De  Launay  thinks  that  the  industrial  consumption  averages  somewhere 
between  40  and  50  per  cent,  of  the  annual  output,  but  believes  that  for 
several  years  past  the  industrial  uses  have  been  absorbing  a  decreasing 
proportion,  though  an  increasing  amount.     (The  World's  Gold,  pp.  176-7.) 

2  Bulletin,  Am.  Econ.  Assoc.,  Fourth  Series,  No.  2,  1910,  pp.  59-61. 


194 


MONEY  AND  PRICES 


the  propositions  which  he  puts  forward  as  links  in  the  chain  of 
reasoning  leading  to  that  conclusion. 

For  example,  Professor  Laughlin  says,  "  A  change  of  prices 
may  be  due  to  changes  in  the  demand  for  and  supply  of 
(thus  including  the  expenses  of  production)  goods  as  well 
as  to  changes  in  the  demand  for  and  supply  of  gold."  This 
proposition  is  true  with  regard  to  changes  in  the  prices  of 
particular  commodities.  The  price  of  wheat  may  rise  or  fall 
as  a  result  of  a  change  in  the  demand  for  or  in  the  supply  of 
wheat.  The  proposition,  however,  is  not  true  with  regard  to 
a  change  in  the  general  level  of  prices.  An  increase  in  the 
supply  of  goods  will  lower  the  level  of  prices  for  the  simple 
reason  that  it  will  increase  the  demand  for  gold.  I  am  not 
certain  that  I  have  understood  Professor  Laughlin's  exposi- 
tion of  his  theory,  but  he  certainly  seemed  to  me  to  argue  that 
there  could  be  a  change  in  the  general  level  of  prices  without 
any  change  whatever  in  the  demand  for  or  supply  of  gold. 
Such  a  position,  it  seems  to  me,  is  absolutely  untenable. 

That  Professor  Laughlin  seeks  to  hold  this  untenable  posi- 
tion, it  seems  to  me,  is  made  evident  by  the  qualification  with 
which  he  accepts  the  statement  that  a  change  in  the  quantity 
of  money,  other  things  being  equal,  would  be  a  factor  affecting 
prices.  He  says,  "  An  increasing  demand  for  gold,  however, 
would  work  against  the  effect  of  an  increasing  supply.  If  the 
new  demand  offset  the  new  supply,  then,  if  changes  of  price 
occurred,  their  cause  must  be  sought  in  the  influences  touching 
the  producing  and  marketing  of  goods."  The  second  con- 
ditional clause  in  that  last  sentence  introduces  an  impossible 
supposition,  for  if  a  new  supply  of  gold  is  offset  by  a  new  de- 
mand for  it,  there  could  be  no  change  in  the  general  level  of 
prices,  so  that  no  cause  for  any  change  would  have  to  be  sought 
in  the  "  influences  touching  the  producing  and  marketing  of 
goods."  Professor  Laughlin  appears  to  have  in  mind  forces 
affecting  the  general  level  of  prices  which  are  entirely  hidden 
from  my  sight.  A  change  in  the  level  of  prices  means  a  change 
in  the  value  of  gold,  and  how  can  there  IDC  a  change  in  that  if 
the  new  demand  for  gold  just  offsets  the  new  supply? 

Professor  Laughlin's  analysis  of  the  price-making  process 
is  incomplete  and  misleading.  He  is  correct  when  he  says  that 


JOSEPH  FRENCH  JOHNSON  195 

the  causes  of  price  changes  must  be  sought  in  the  forces  settling 
particular  prices,  but  he  is  manifestly  wrong  when  he  states 
that  the  price  of  wheat  is  "  arrived  at  by  the  higgling  of  the 
market,  which  depends  on  the  buyers'  and  sellers'  judgment 
of  the  demand  for  and  supply  of  wheat."  Such  higgling  would 
determine  only  the  value  of  wheat.  The  price  of  wheat  is  not 
fixed  until  buyer  and  seller  have  reached  an  agreement  in  their 
estimates  as  to  the  value  not  only  of  wheat,  but  also  of  money. 
If  wheat  is  comparatively  easy  to  get,  the  price  falls.  If  money 
is  easier  to  get,  the  price  rises.  The  demand  for  and  supply 
of  money  is  evidently  just  as  important  in  the  determination 
of  the  price  of  wheat  as  is  the  demand  for  and  supply  of  wheat 
itself.  When  Professor  Laughlin  says  that  the  offer  of  money 
for  goods  is  only  a  resultant  of  price-making  forces  previously 
at  work,  he  must  have  in  mind  some  price-making  process  and 
price-making  forces  of  which  I  have  never  heard.  I  know  of 
no  market  in  which  goods  are  lowered  in  price  except  for  the 
reason  that  at  the  higher  price  not  enough  money  is  offered  to 
absorb  the  supply;  nor  of  any  market  in  which  goods  are 
raised  in  price  except  for  the  reason  that  buyers  are  willing 
to  offer  more  money  for  the  goods. 

In  his  analysis  of  credit  and  its  relation  to  the  value  of 
money,  Professor  Laughlin  seems  to  me  to  have  in  mind  a 
hypothetical  financial  world,  the  like  of  which  does  not  and 
could  not  exist  on  earth.  He  strives  to  show  that  a  bank's 
ability  to  make  loans  depends  upon  the  amount  of  its  capital 
and  deposits,  and  that  therefore  any  increase  in  the  supply  of 
gold  would  not  in  itself  lead  to  an  increase  of  loans.  "  Ex- 
pansion of  business,"  he  remarks,  "  is  not  a  direct  consequence 
of  an  increasing  supply  of  gold  any  more  than  an  expansion  of 
railway  traffic  is  the  direct  consequence  of  an  increasing  supply 
of  cars."  He  is  quite  right  if  he  means  that  an  increase  in  the 
amount  of  gold  will  not  necessarily  cause  the  exchange  of 
more  goods.  But  this  does  not  appear  to  be  his  meaning.  He 
holds  that  the  use  of  new  gold  in  bank  reserves  cannot  be  a 
causal  force  raising  prices,  for  the  bankers  cannot  increase 
their  loans,  in  his  opinion,  unless  the  condition  of  business 
demands  such  an  increase.  In  his  hypothetical  financial  world 
bankers  are  willing  to  carry  idle  stocks  of  gold  and  to  wait 


196  MONEY  AND  PRICES 

until  business  conditions  make  necessary  an  increase  in  their 
loans.  In  the  real  financial  world,  of  course,  bankers  do  noth- 
ing of  the  sort  Bankers  with  surplus  gold  immediately  tempt 
borrowers  by  lowering  the  rate  of  discount  and  thus  increas- 
ing the  money  demand  for  goods  in  the  markets.  As  a  result 
there  is  an  irregular  and  general  rise  of  prices.  More  goods 
may  not  be  bought  and  sold  and  there  may  be  no  expansion  of 
business,  but  expressed  in  terms  of  money  the  totals  are  bigger. 
There  is  no  analogy  between  dollars  and  freight  cars.  The 
carrying  capacity  of  a  car  is  fixed  and  unchangeable,  but  the 
carrying  capacity  of  a  dollar  is  elastic  —  so  elastic,  in  fact, 
that  dollars  are  always  fully  loaded  no  matter  how  small  the 
supply  of  goods.  As  Professor  Laughlin  points  out,  although 
he  apparently  does  not  see  its  significance,  the  new  demand  for 
gold  since  1895  has  "  roughly  equalled  the  .new  supply." 
Surely  it  could  not  have  been  otherwise,  and  no  statistics  are 
necessary  to  prove  the  fact. 

Murray  S.  Wildman 1 :  My  comments  on  these  interest- 
ing papers  will  be  directed  upon  the  methods  employed,  and 
certain  assumptions  involved,  in  the  arguments  of  both. 
Granting  that  Professor  Fisher's  analysis  shows  a  perfect  cor- 
respondence between  the  course  of  prices  on  the  one  hand  and 
the  quantity  of  money  and  credit  instruments  on  the  other 
hand,  I  am  still  unable  to  see  which  magnitudes  are  properly 
to  be  regarded  as  causes  and  which  as  effects.  That  varia- 
tions in  the  value  of  gold  and  in  the  price  level  must  be  recipro- 
cal, all  will  admit.  If  we  regard  M  as  denoting  the  gold  supply 
for  the  present,  a  causal  relation  between  M  and  P  cannot  be 
denied.  But  may  it  not  be  possible  that  variations  in  M',  or 
credit,  and  V  and  V,  the  velocity  of  circulation  of  both  money 
and  credit,  be  simply  in  consequence  of  the  variation  in  M 
and  P  ?  Why  is  P  the  only  passive  term  or  why  is  it  passive 
at  all? 

Suppose  that  the  problem  set  was  to  discover  the  cause  of 
credit  expansion  from  1896  to  1910.  Would  we  not  seek  at 
once  to  explain  it  by  reference  to  rising  prices  and  greater 
volume  of  goods,  making  a  broader  basis  for  credit,  while 

1  Ibid.,  pp.  61-63. 


MURRAY  S.  WILDMAN  197 

along  with  that  is  a  greater  gold  supply  which  promotes  the 
convertibility  of  an  extended  credit?  Then  might  we  not  in- 
voke Professor  Fisher's  algebraic  formula,  with  terms  rear- 
ranged, and  show  by  this  method  of  reasoning,  supported  by 
statistical  verification,  that  the  high  prices  afford  an  adequate 
cause  for  the  present  expansion  of  credit? 

But  we  are  seeking  the  cause  or  causes  of  rise  in  the  price 
level.  This  is  equivalent  to  seeking  the  cause  of  decline  in  the 
value  of  gold.  Does  the  "quantity  theory"  as  newly  ex- 
pounded give  us  the  solution?  I  think  not.  Rather  it  shows 
us  that  as  gold  has  grown  in  supply,  and  fallen  in  value, 
credit  has  grown  in  magnitude  and  in  rapidity  of  circulation, 
and  that  these  changes  in  values  and  volumes  have  gone  hand 
in  hand  with  proportional  changes  in  the  price  level  and  in  the 
magnitude  of  commodity  exchanges. 

This  view  of  the  case  brings  me  to  substantial  approval  of 
Professor  Laughlin's  method  of  analysis  and  argument.  That 
is,  we  must  seek  the  facts  regarding  supply  and  demand  as  ap- 
plied to  gold,  and  those  which  bear  upon  supply  and  demand 
as  touching  goods,  in  so  far  as  the  demand  for  goods  is  ex- 
pressed in  offers  of  gold  and  gold  representatives.  Here  the 
algebraic  formula  would  be  invoked  to  support  his  reasoning 
since  M'  and  V  and  V  may  be  regarded  as  factors  in  the 
demand  for  gold. 

To  accept  Professor  Laughlin's  method  does  not  involve  the 
necessity  of  his  conclusions.  The  terms,  by  this  method,  do 
not  lend  themselves  to  exact  mathematical  statement  and 
statistical  proof,  so  conclusions  cannot  be  exact  and  definite. 
This  may  be  illustrated  in  a  consideration  of  demand  for  gold. 
Some  say  that  demand  has  grown  step  by  step  with  supply  and 
therefore  gold  has  not  been  cheapened.  Others  say  that  supply 
has  grown  more  rapidly  than  demand,  and  so  gold  has  been 
cheapened  and  to  that  extent  prices  are  raised. 

Either  statement  may  be  wrong.  I  do  not  believe  we  have 
yet  any  reliable  data  regarding  the  demand  for  gold  in  the 
sense  of  a  value-making  factor.  Most  efforts  to  measure  de- 
mand are  based  on  statistics  of  gold  in  use.  If  one  can  show 
that  consumption  of  gold  in  the  arts,  in  the  circulation,  and  in 
greater  bank  reserves,  has  increased  pari  passu  with  produc- 


198  MONEY  AND  PRICES 

lion,  we  are  told  that  the  value  of  gold  has  not  been  lowered 
by  the  greater  supply. 

But  statistics  of  consumption  give  no  clue  to  demand  in  the 
value-determining  sense.  We  have  many  staple  commodities, 
such  as  wheat  and  cotton,  whose  price  drops  sharply  when  the 
supply  exceeds  a  certain  normal  volume,  even  though  the  whole 
crop  is  consumed.  Statistically  speaking,  the  demand  for  a 
cotton  crop  always  rises  as  supply  rises,  and  falls  as  supply 
falls,  but  that  is  because  demand  and  supply  become  equated 
through  a  variation  in  price.  Demand,  in  this  sense  of  quan- 
tity demanded,  is  in  part  a  result  rather  than  a  cause  of 
value. 

When  we  can  properly  speak  of  demand  as  potent  for  the 
determination  of  value,  we  are  thinking  of  demand  from  the 
point  of  view  of  intensity  rather  than  the  point  of  view  of 
magnitude.  But  the  demand  which  makes  for  value  —  de- 
mand intensively  considered  —  is  only  measured  by  the  pur- 
chasing power  offered.  Applied  to  gold,  I  know  of  no  measure 
of  demand  except  in  the  goods  and  services  offered  in  ex- 
change. To  say  that  goods  and  services  offered  for  an  ounce 
of  gold  in  1910  are  less  than  are  offered  for  an  ounce  of  gold 
in  1896,  is  simply  to  say  that  prices  are  higher.  But  it  is  these 
prices  that  we  are  trying  to  explain  by  giving  the  effect  for 
the  cause,  when  we  say  that  demand  has  risen  with  supply. 

Those  staple  commodities  whose  value  falls  off  abruptly 
with  any  increase  of  supply  beyond  a  customary  stock  are 
said  to  be  subject  to  an  inelastic  demand,  and  those  whose 
value  declines  uniformly  with  excessive  supplies  are  said  to 
have  an  elastic  demand.  Is  the  demand  for  gold  elastic,  or 
is  it  inelastic?  And  is  it  possible  by  independent  analysis  to 
construct  the  curve  of  elasticity  which  properly  belongs  to  gold, 
and  so  avoid  circular  reasoning  from  the  very  prices  we  are 
trying  to  explain  ? 

If  the  demand  for  gold  is  inelastic  and  the  demand  curve 
drops  off  abruptly  after  a  certain  supply  is  in  evidence,  the 
presumption  is  that  in  the  conditions  of  gold  production,  rather 
than  in  the  conditions  of  commodity  production,  lies  the  cause 
of  our  high  prices.  Moreover,  if  this  be  the  case,  we  can 
readily  see  the  cause  of  cheapening  of  gold,  even  though  the 


T.  N.  CARVER  199 

product  of  a  single  year  bears  a  small  proportion  to  the  ex- 
isting stock. 

If  on  the  other  hand  the  demand  for  gold  be  very  elastic, 
so  that  it  expands  with  growing  supplies  with  no  substantial 
alterations  in  value,  then  we  are  driven  to  seek  the  cause  of 
high  prices  in  influences  directly  touching  the  goods  and  serv- 
ices rather  than  in  those  directly  affecting  gold. 

It  would  seem  therefore  that  both  methods  of  treatment 
have  left  something  to  be  desired.  The  algebraic  analysis,  even 
as  verified,  presents  the  relations  between  magnitudes  without 
showing  the  cause  of  high  prices.  The  argument  directed  im- 
mediately at  the  value  of  gold  of  necessity  involves  considera- 
tion of  the  demand  for  gold,  which,  as  a  price-making  factor, 
remains  an  unknown  quantity. 

T.  N.  Carver  * :  Professor  Fisher  .  .  .  has  demonstrated 
beyond  all  question  the  accuracy  of  his  formula.  The  ques- 
tion remains,  however,  whether  his  formula  supports  his  own 
conclusion  or  Professor  Laughlin's.  If,  for  example,  it  should 
be  found  that  P  is  the  cause  of  M,  the  formula  would  to  that 
extent  support  Professor  Laughlin's  position.  I  believe  that 
to  a  certain  extent  P  is  actually  the  cause  of  M.  If  the  grow- 
ing scarcity  of  agricultural  land,  or  the  increase  in  population 
and  the  increased  demand  for  agricultural  products  without  an 
increase  in  land,  should  increase  the  marginal  cost  of  producing 
agricultural  products  to  supply  this  larger  demand,  that  would 
tend  to  increase  the  exchange  value  of  these  products,  even 
according  to  the  formula  of  Cairnes  as  quoted  by  President 
Houston.2  Even  without  any  increase  in  the  gold  supply,  this 
would  cause  each  unit  of  product  to  exchange  for  a  little  more 
gold;  then,  in  order  that  a  given  number  of  exchanges  in 
agricultural  products  could  be  carried  on,  it  would  be  necessary 
to  have  a  larger  number  of  ounces  of  gold,  or  a  larger  number 
of  gold  coins,  or  some  other  form  of  money  of  given  denomina- 
tions to  do  the  money  work.  This,  in  other  words,  would 
necessitate  a  larger  supply  of  money;  and,  if  other  forms  than 
gold  were  not  forthcoming,  it  would  necessitate  that  a  larger 

1  Ibid.,  p.  64. 

2  The  quotation  here  referred  to  is  omitted. —  EDITOR. 


200  MONEY  AND  PRICES 

proportion  of  the  stock  of  gold  should  be  coined  into  money 
in  order  to  do  the  work.  Thus,  without  any  increase  whatever 
in  the  world's  total  gold  supply,  there  would  come  to  be  an 
increase  in  the  proportion  of  that  supply  used  as  money,  or  in 
the  amount  of  gold  coin  actually  used  in  circulation.  I  be- 
lieve that  this  has  taken  place,  and  that  it  is  one  of  the  factors 
in  the  problem,  although  there  has  also  been  a  very  large  in- 
crease in  the  gold  supply  to  still  further  accentuate  the  tend- 
ency. 

F.  W.  Taussig 1 :  I  congratulate  Professor  Fisher  on  his 
admirable  paper.  I  am  in  accord  with  him  in  his  method  of 
reasoning  and  in  all  his  essential  results.  His  investigation 
of  this  subject  adds  another  to  the  brilliant  studies  with  which 
he  has  enriched  economic  science. 

It  deserves  to  be  said,  perhaps,  that  the  term  M'  (deposits) 
in  his  equation  is  not  entirely  independent,  but  is  in  some  de- 
gree a  function  of  T.  I  say  to  some  degree;  it  is  dependent 
on  T  in  part  only,  and  not  for  very  long  periods.  Professor 
Fisher  has  here  treated  it  as  dependent  simply  on  M.  ...  He 
has  indicated  the  qualifications  which  must  be  attached  to  this 
dependence  of  deposits  on  bank  reserves.  He  has  pointed  out 
that  though  a  general  dependence  appears  over  long  periods 
of  time,  it  is  affected  by  changes  in  banking  ways,  and  by  the 
tendency  to  build  up  a  higher  superstructure  of  deposits  in 
times  of  active  business.  But  there  is  also  a  connection  be- 
tween T,  volume  of  trade,  and  M'.  That  is,  for  short  periods 
—  nay,  for  periods  of  sortie  years  —  an  increasing  volume  of 
trade  tends  of  itself  to  bring  about  an  increasing  volume  of 
deposits.  (I  may  say,  parenthetically,  that  "  volume  of  trade  " 
does  not  seem  to  me  an  apt  expression;  "  units  of  commodi- 
ties," the  other  phrase  used  by  Professor  Fisher,  is  better.) 
Though  I  would  by  no  means  go  the  length  of  Professor 
Laughlin's  reasoning,  which  seems  to  imply  that  every  act  of 
exchange  supplies  automatically  its  own  medium  of  exchange, 
it  does  seem  to  me  that  our  modern  mechanism  of  deposit  bank- 
ing supplies  an  elastic  source  of  deposits,  which,  for  consider- 
able periods,  enables  them  to  run  pari  passu  with  the  transac- 

id,,  pp.  64-65. 


RALPH  H.  HESS  2OI 

tions  and  loans  resting  on  them.  In  the  «nd,  an  increase  of 
deposits  finds  its  limit  in  the  volume  of  cash  held  by  the  banks 
But  there  is  some  elasticity  of  adjustment,  by  which  loans  and 
deposits  increase  as  fast  as  transactions  or  faster;  and  this 
accounts  in  no  small  degree  for  the  rise  in  prices  during  periods 
of  activity.  The  phenomenon  shows  itself  most  strikingly  in 
stock  exchange  loans,  especially  in  a  center  like  New  York. 
There  the  business  creates  for  itself  quasi-automatically  its  own 
medium  of  exchange.  I  suspect  it  is  undue  generalization 
from  operations  of  this  sort  that  has  led  Professor  Laughlin  to 
take  his  extreme  position  —  a  position  which  I  can  not  but 
think  untenable.  Some  allowance  for  the  temporary  interac- 
tion between  M'  and  T  is  necessary  for  the  completeness  of 
Professor  Fisher's  reasoning. 

Ralph  H.  Hess1:  Professor  Fisher's  formula  (MV + 
M'V'=PT)  approximately  expresses  the  mathematical  equal- 
ity of  purchase  and  payment  which  cannot  be  questioned.  I 
say  approximately  because  M'  (defined  by  Professor  Fisher 
as  "  bank  deposits  subject  to  check  "),  if  it  be  made  to  express 
an  accurate  measure  of  circulating  credit,  should  include  not 
only  open  bank  accounts,  but  certain  other  values  which  con- 
stitute current  means  of  payment,  such  as  bankers'  bills,  trade 
bills,  cashiers'  checks,  and  certified  checks.  .  .  . 

The  relation  which  Professor  Taussig  has  pointed  out  be- 
tween M'  and  T  (the  value  of  negotiable  credit  and  the  con- 
temporary volume  of  trade}  is  not  only  possible,  but,  in  any 
community  of  modernized  commerce,  is  actual.  Moreover,  a 
knowledge  of  the  process  by  which  commerce  is  financed  by  the 
existing  mechanism  of  discount,  loan,  deposit,  and  draft  justi- 
fies the  conclusion  that,  if  the  volume  of  trade  (T)  be  resolved 
into  its  factors,  namely,  materials  of  trade  and  their  frequency 
of  exchange,  the  latter  factor  of  T  is  quite  commensurate  with 
the  velocity  of  credit  (V)- 

To  me  it  seems  incontestable  that  the  volume  and  velocity  of 
credit  currency,  as  represented  by  bank  deposits  and  other 
circulating  media,  vary  directly  as  the  volume  and  value  of 
the  materials  of  trade  in  the  process  of  exchange,  and  are, 

1  Ibid.,  pp.  65-67. 


202  MONEY  AND  PRICES 

mathematically  speaking,  dependent  functions  thereof.  Grant- 
ing this  relation,  an  analysis  of  the  equation  of  exchange  es- 
tablishes PT  as  the  major  determinant  of  M'V,  and,  in  so 
far  as  paper  money  may  be  authorized  and  issued  upon  the 
security  of  commercial  assets,  of  M.  That  part  of  the  money 
in  circulation  which  does  not  derive  its  circulating  powers  from 
actual  and  potential  commercial  values  is  itself  material  of 
barter  incorporating  so-called  intrinsic  values. 

The  conclusion  is  clear  that  P  (price)  is  independent  of  all 
other  terms  and  factors  of  Professor  Fisher's  equation,  that 
V  and  V  are  determined  by  the  mechanical  circumstances  and 
organization  of  exchange,  and  that  the  value  of  M  and  M', 
taken  collectively,  is  a  spontaneous  derivative  of  PT.  The 
fundamental  determinants  of  prices  and  of  "  price  levels," 
therefore,  are  to  be  found  outside  of  monetary  and  credit 
agencies  per  se. 

As  to  the  nature  and  order  of  the  price-making  process  and 
the  actual  forces  behind  price  movements,  I  am  in  substantial 
accord  with  Professor  Laughlin.  That  prices,  individually 
and  collectively  considered,  express  the  value-proportion  of 
demand  for  and  supply  of  goods  on  the  market  to  demand  for 
and  "  visible  supply  "of  the  standard  commodity  is  funda- 
mentally logical.  Nor  is  there  occasion  to  quibble  over  the 
paradox  of  disturbed  equilibrium  of  demand  and  supply.  Phy- 
sically considered,  the  goods  which  objectify  these  terms  are, 
of  course,  identical ;  but,  in  the  valuation  process,  demand  and 
supply  denominate,  respectively,  desire  and  utility  —  the  gen- 
erally acknowledged  antecedents  of  value.  Price  is  the  equal- 
izing factor  between  the  effective  demand  for  gold  and  the 
effective  demand  for  other  goods,  each  taken  in  conventional 
units ;  and  price  changes  are  resultants  of,  and  commensurate 
with,  net  variations  in  the  value-factors  of  the  standard  and 
of  the  objects  of  exchange. 

Referring  to  the  nature  of  credit  and  the  economic  qualities 
of  credit  instruments,  the  somewhat  figurative  expression 
"  goods  coined  into  a  means  of  payment "  is  a  striking  and 
accurate  characterization.  It  is  possible  that  all  legitimate 
market  values,  under  normal  trade  conditions,  may  be  liquid- 
ized through  credit  agencies,  and  the  goods  in  which  they  are 


J.  LAURENCE  LAUGHLIN  203 

incorporated  be  thus  rendered  immediately  and  conveniently 
exchangeable.  This  process  may  be  consummated  independ- 
ently of  prices  and  with  slight  regard  to  the  actual  supply  of 
money.  The  truth  of  this  assertion  is,  in  fact,  demonstrated 
daily  in  the  marts  of  trade. 

J.  Laurence  Laughlin  * :  There  is  time  to  answer  briefly 
only  a  few  of  the  points  raised  by  several  speakers.  First, 
Professor  Fisher's  equation  of  M  V  -f-  M'  V  =  PT  is  to  my 
mind  not  a  solution,  but  only  a  statement,  of  the  problem  of 
price  levels.  It  can  be  read  backward  as  well  as  forward. 
For  instance,  it  does  not  follow  that  the  level  of  prices  (P) 
will  rise  with  an  increase  of  M',  since  —  as  Professor  Taussig 
has  pointed  out  already  —  an  active  development  of  trade  and 
industry  (T)  would  itself  be  a  reason  for  an  increase  of  bank- 
ing loans  and  deposits  subject  to  check  (M'),  thus  equalizing 
effects  on  both  sides  of  the  equation  without  necessarily  in- 
creasing P.  This  result  is,  in  fact,  one  of  the  points  on  which 
I  have  steadily  insisted  in  my  own  exposition  of  the  theory  of 
prices  and  credit;  and  Professor  Fisher's  equation  allows  it 
to  appear  distinctly.  His  equation  does  not  show  causes;  it 
states  a  static  situation,  into  which  various  causes  may  be  read. 
The  facts  between  1876  and  1896  disclose  an  increase  of  bank 
deposits  of  500  or  600  per  cent,  and  yet  that  period  was  dis- 
tinguished as  one  of  falling  prices.  Therefore  M'  cannot  be 
regarded  as  having  been  proved  to  be  a  cause  of  higher  prices. 

Second,  Professor  Fisher  .  .  .  seeks  to  establish  a  causal 
relation  between  the  amount  of  money  in  circulation  (M)  and 
the  amount  of  deposits  (M')  which,  in  my  judgment,  is  wholly 
unfounded.  He  has  developed  this  in  his  paper  in  the  Royal 
Statistical  Journal.  The  error  consists  in  supposing  that  a 
man's  deposit  account  at  any  time  varies  with  the  amount  of 
money  in  his  possession.  Rather,  the  deposit  account  varies 
with  a  man's  wealth.  The  rich  man  does  not  carry  much 
more  money  to  pass  from  hand  to  hand  than  the  man  of 
moderate  means.  Monetary  habits  in  the  community  require 
a  certain  level  of  circulation  for  all  persons,  but  the  deposits 
of  an  individual  may  soar  above  the  common  level  without  re- 

1  Ibid.,  pp.  67-69. 


204  MONEY  AND  PRICES 

gard  to  the  money  he  keeps  in  circulation.  His  bank  deposits 
are  rather  a  measure  of  the  saleable  goods  he  has  sold,  "  coined 
into  means  of  payment" 

Third,  I  well  recognize  the  high  position  Professor  Fisher 
occupies  in  the  mathematical  school  of  Walras  and  others;  but 
has  he  not  made  an  error  in  stating  the  essence  of  the  price 
relation  in  his  mathematical  symbols?  So  far  as  I  understand 
him,  he  seems  to  deny  the  fundamental  value-concept  (on 
which  there  has  hitherto  been  general  agreement)  that  price  is 
a  ratio  between  goods  and  gold.  In  furtherance  of  that  idea, 
he  thinks  that,  before  individual  prices  can  be  arrived  at,  the 
general  price  level  must  be  ascertained.  Now,  in  my  exposi- 
tion using  the  ratio-concept,  I  explained  in  detail  how  the  gen- 
eral level  of  prices  might  be  affected  by  causes  affecting  the 
gold  side  of  the  ratio.  Therefore,  I  did  not  neglect  to  account 
for  the  general  level  and  that  too  without  doing  violence  to  the 
accepted  value-concept.  But  the  ratio-concept  (which  Pro- 
fessor Fisher  seems  to  deny)  allows  the  forces  acting  on  goods 
also  to  affect  the  general  level  of  prices  as  I  have  shown.  In 
my  opinion,  he  wrongly  works  from  a  general  level  of  prices 
to  particular  prices;  while  I  hold  that  particular  prices,  or 
actual  quotations,  are  the  bases  from  which  all  averages,  or 
price  levels,  are  always  and  inevitably  computed.  Moreover, 
in  his  diagrams,  the  level  of  prices  he  used  was  the  one  com- 
puted from  individual  quotations.  Hence  his  whole  reason- 
ing on  the  conformity  of  the  statistics  to  the  terms  of  his 
equation  is  vitiated.  Indeed  the  better  agreement  he  finds  — 
after  elaborate  statistical  computations  —  between  the  elements 
and  their  result  on  prices  .  .  .  — is  due,  I  think,  to  relying 
on  an  equation  which  is  nothing  more  than  a  statement  that 
the  whole  is  equal  to  the  sum  of  its  parts.  .  .  . 

Finally,  when  Professor  Johnson  suggests  that  I  am  wrong 
in  stating  that  forces  affecting  the  goods  side  of  the  price  ratio 
have  an  influence  on  prices,  he  certainly  cannot  mean  that 
conditions  affecting  the  producing,  marketing,  and  financing 
of  goods  have  no  effect  on  prices.  How  else,  for  instance,  can 
we  explain  the  rise  of  the  prices  of  agricultural  products? 
The  special  causes  affecting  them  have  little  to  do  with  the 
quantity  of  "  money."  Moreover,  the  term  "  money  "  itself 


IRVING  FISHER  205 

is  used  so  loosely  and  vaguely  that  we  can  come  to  agreement 
on  price  theories  only  by  first  agreeing  upon  what  we  mean 
by  "  money."  In  my  paper,  I  have  discussed  the  relations  of 
goods,  and  their  prices,  to  gold.  But,  in  this  country,  we  use 
gold  little  as  a  medium  by  which  goods  are  exchanged.  Thus 
the  relation  of  the  prices  of  goods  to  our  media  of  exchange 
has  been  practically  omitted.  And  yet  the  price-making  process 
generally  precedes  the  creation  of  the  usual  banking  media  of 
exchange  by  which  most  goods  are  exchanged. 

Irving  Fisher * :  In  connection  with  the  statement  and 
explanation  of  the  equation  of  exchange  it  was  shown  (i) 
that  prices  vary  directly  as  the  quantity  of  money,  provided  the 
volume  of  trade  and  the  velocities  of  circulation  remain  un- 
changed; (2)  that  prices  vary  directly  as  the  velocities  of 
circulation  (if  these  velocities  vary  together),  provided  the 
quantity  of  money  and  the  volume  of  trade  remain  unchanged, 
and  (3)  that  prices  vary  inversely  as  the  volume  of  trade, 
provided  the  quantity  of  money  —  and  therefore  deposits  — 
and  their  velocities  remain  unchanged. 

Let  us  now  inquire  how  far  these  propositions  are  really 
causal  propositions.  An  examination  of  the  influence  of  each 
of  the  six  magnitudes  on  each  of  the  other  five  will  afford  an- 
swers to  the  objections  which  have  been  raised  to  the  quantity 
theory  of  money. 

To  set  forth  all  the  facts  and  possibilities  as  to  causation 
we  need  to  study  the  effects  of  varying,  one  at  a  time,  the 
various  magnitudes  in  the  equation  of  exchange. 

Our  first  question  is:  given  (say)  a  doubling  of  the  quan- 
tity of  money  in  circulation  (M)  what  are  the  normal  or  ulti- 
mate effects  on  the  other  magnitudes  in  the  equation  of  ex- 
change, viz. :  M',  V ,  V,  the  p's  and  the  Q's? 

We  have  seen  that  normally  the  effect  of  doubling  money 
in  circulation  (M)  is  to  double  deposits  (M')  because  under 
any  given  conditions  of  industry  and  civilization  deposits  tend 
to  hold  a  fixed  or  normal  ratio  to  money  in  circulation.  Hence 

1  Adapted  from  The  Purchasing  Power  of  Money,  pp.  150-15?;  and  Bul- 
letin of  the  American  Economic  Association,  Fourth  Series,  No.  2,  Papers 
and  Discussions  of  the  Twenty-third  Annual  Meeting,  December,  1910.  p. 
70. 


206  MONEY  AND  PRICES 

the  ultimate  effect  of  a  doubling  in  M  is  the  same  as  that  of 
doubling  both  M  and  M'.  We  propose  next  to  show  that  this 
doubling  of  M  and  M'  does  not  normally  change  F,  V  or  the 
Q's,  but  only  the  />'s.  The  equation  of  exchange  of  itself  does 
not  affirm  or  deny  these  propositions. 

For  aught  the  equation  of  exchange  itself  tells  us,  the  quan- 
tities of  money  and  deposits  might  even  vary  inversely  as  their 
respective  velocities  of  circulation.  Were  this  true,  an  in- 
crease in  the  quantity  of  money  would  exhaust  all  its  effects 
in  reducing  the  velocity  of  circulation,  and  could  not  produce 
any  effect  on  prices.  If  the  opponents  of  the  "  quantity  the- 
ory "  could  establish  such  a  relationship,  they  would  have 
proven  their  case  despite  the  equation  of  exchange.  But  they 
have  not  even  attempted  to  prove  such  a  proposition.  As  a 
matter  of  fact,  the  velocities  of  circulation  of  money  and  of 
deposits  depend,  as  will  be  seen,  on  technical  conditions  and 
bear  no  discoverable  relation  to  the  quantity  of  money  in  cir- 
culation. Velocity  of  circulation  is  the  average  rate  of  "  turn- 
over," and  depends  on  countless  individual  rates  of  turnover. 
These  depend  on  individual  habits.  Each  person  regulates  his 
turnover  to  suit  his  convenience.  A  given  rate  of  turnover  for 
any  person  implies  a  given  time  of  turnover  —  that  is,  an  aver- 
age length  of  time  a  dollar  remains  in  his  hands.  He  adjusts 
this  time  of  turnover  by  adjusting  his  average  quantity  of 
pocket  money,  or  till  money,  to  suit  his  expenditures.  He  will 
try  to  avoid  carrying  too  little  lest,  on  occasion,  he  be  unduly 
embarrassed;  and  on  the  other  hand  to  avoid  encumbrance, 
waste  of  interest,  and  risk  of  robbery,  he  will  avoid  carrying 
too  much.  Each  man's  adjustment  is,  of  course,  somewhat' 
rough,  and  dependent  largely  on  the  accident  of  the  moment; 
but,  in  the  long  run  and  for  a  large  number  of  people,  the  aver- 
age rate  of  turnover,  or  what  amounts  to  the  same  thing,  the 
average  time  money  remains  in  the  same  hands,  will  be  very 
closely  determined.  It  will  depend  on  density  of  population, 
commercial  customs,  rapidity  of  transport,  and  other  technical 
conditions,  but  not  on  the  quantity  of  money  and  deposits  nor 
on  the  price  level.  These  may  change  without  any  effect  on 
velocity.  If  the  quantities  of  money  and  deposits  are  doubled, 
there  is  nothing,  so  far  as  velocity  of  circulation  is  concerned, 


IRVING  FISHER  207 

to  prevent  the  price  level  from  doubling.  On  the  contrary, 
doubling  money,  deposits,  and  prices  would  necessarily  leave 
velocity  quite  unchanged.  Each  individual  would  need  to 
spend  more  money  for  the  same  goods,  and  to  keep  more  on 
hand.  The  ratio  of  money  expended  to  money  on  hand  would 
not  vary.  If  the  number  of  dollars  in  circulation  and  in  de- 
posit should  be  doubled  and  a  dollar  should  come  to  have  only 
half  its  former  purchasing  power,  the  change  would  imply 
merely  that  twice  as  many  dollars  as  before  were  expended  by 
each  person  and  twice  as  many  kept  on  hand.  The  ratio  of 
expenditure  to  stock  on  hand  would  be  unaffected. 

If  it  be  objected  that  this  assumes  that  with  the  doubling  in 
M  and  M'  there  would  be  also  a  doubling  of  prices,  we  may 
meet  the  objection  by  putting  the  argument  in  a  slightly  differ- 
ent form.  Suppose,  for  a  moment,  that  a  doubling  in  the  cur- 
rency in  circulation  should  not  at  once  raise  prices,  but  should 
halve  the  velocities  instead;  such  a  result  would  evidently 
upset  for  each  individual  the  adjustment  which  he  had  made 
of  cash  on  hand.  Prices  being  unchanged,  he  now  has  double 
the  amount  of  money  and  deposits  which  his  convenience  had 
taught  him  to  keep  on  hand.  He  will  then  try  to  get  rid  of 
the  surplus  money  and  deposits  by  buying  goods.  But  as 
somebody  else  must  be  found  to  take  the  money  off  his  hands, 
its  mere  transfer  will  not  diminish  the  amount  in  the  com- 
munity. It  will  simply  increase  somebody  else's  surplus. 
Everybody  has  money  on  his  hands  beyond  what  experi- 
ence and  convenience  have  shown  to  be  necessary.  Every- 
body will  want  to  exchange  this  relatively  useless  extra 
money  for  goods,  and  the  desire  so  to  do  must  surely  drive  up 
the  price  of  goods.  No  one  can  deny  that  the  effect  of  every 
one's  desiring  to  spend  more  money  will  be  to  raise  prices. 
Obviously  this  tendency  will  continue  until  there  is  found  an- 
other adjustment  of  quantities  to  expenditures,  and  the  Vs 
are  the  same  as  originally.  That  is,  if  there  is  no  change  in 
the  quantities  sold  (the  Q's),  the  only  possible  effect  of  doub- 
ling M  and  M'  will  be  a  doubling  of  the  />'s;  for  we  have  just 
seen  that  the  F's  cannot  be  permanently  reduced  without  caus- 
ing people  to  have  surplus  money  and  deposits,  and  there  can- 
not be  surplus  money  and  deposits  without  a  desire  to  spend 


208  MONEY  AND  PRICES 

it,  and  there  cannot  be  a  desire  to  spend  it  without  a  rise  in 
prices.  In  short,  the  only  way  to  get  rid  of  a  plethora  of 
money  is  to  raise  prices  to  correspond. 

So  far  as  the  surplus  deposits  are  concerned,  there  might 
seem  to  be  a  way  of  getting  rid  of  them  by  cancelling  bank 
loans,  but  this  would  reduce  the  normal  ratio  which  M'  bears 
to  M,  which  we  have  seen  tends  to  be  maintained. 

We  come  back  to  the  conclusion  that  the  velocity  of  circu- 
lation either  of  money  or  deposits  is  independent  of  the  quan- 
tity of  money  or  of  deposits.  No  reason  has  been,  or,  so  far 
as  is  apparent,  can  be  assigned,  to  show  why  the  velocity  of 
circulation  of  money,  or  deposits,  should  be  different,  when 
the  quantity  of  money,  or  deposits,  is  great,  from  what  it  is 
when  the  quantity  is  small. 

There  still  remains  one  seeming  way  of  escape  from  the 
conclusion  that  the  sole  effect  of  an  increase  in  the  quantity  of 
money  in  circulation  will  be  to  increase  prices.  It  may  be 
claimed  —  in  fact  it  has  been  claimed  —  that  such  an  increase 
results  in  an  increased  volume  of  trade.  We  now  proceed  to 
show  that  (except  during  transition  periods)  the  volume  of 
trade,  like  the  velocity  of  circulation  of  money,  is  independent 
of  the  quantity  of  money.  An  inflation  of  the  currency  cannot 
increase  the  product  of  farms  and  factories,  nor  the  speed  of 
freight  trains  or  ships.  The  stream  of  business  depends  on 
natural  resources  and  technical  conditions,  not  on  the  quantity 
of  money.  The  whole  machinery  of  production,  transporta- 
tion, and  sale  is  a  matter  of  physical  capacities  and  technique, 
none  of  which  depend  on  the  quantity  of  money.  The  only 
way  in  which  the  quantities  of  trade  appear  to  be  affected  by 
the  quantity  of  money  is  by  influencing  trades  accessory  to  the 
creation  of  money  and  to  the  money  metal.  An  increase  of 
gold  money  will,  as  has  been  noted,  bring  with  it  an  increase 
in  the  trade  in  gold  objects.  It  will  also  bring  about  an  in- 
crease in  the  sales  of  gold  mining  machinery,  in  gold  miners' 
services,  in  assaying  apparatus  and  labor.  These  changes  may 
entail  changes  in  associated  trades.  Thus  if  more  gold  orna- 
ments are  sold,  fewer  silver  ornaments  and  diamonds  may  be 
sold.  Again  the  issue  of  paper  money  may  affect  the  paper 
and  printing  trades,  the  employment  of  bank  and  government 


IRVING  FISHER  209 

clerks,  etc.  In  fact,  there  is  no  end  to  the  minute  changes  in 
the  Q's  which  the  changes  mentioned,  and  others,  might  bring 
about.  But  from  a  practical  or  statistical  point  of  view  they 
amount  to  nothing,  for  they  could  not  add  to  nor  subtract  one- 
tenth  of  i  per  cent,  from  the  general  aggregate  of  trade.  Only 
a  very  few  Q's  would  be  appreciably  affected,  and  those  few 
very  insignificant. 

We  conclude,  therefore,  that  a  change  in  the  quantity  of 
money  will  not  appreciably  affect  the  quantities  of  goods  sold 
for  money. 

Since,  then,  a  doubling  in  the  quantity  of  money :  ( I )  will 
normally  double  deposits  subject  to  check  in  the  same  ratio, 
and  (2)  will  not  appreciably  affect  either  the  velocity  of  circu- 
lation of  money  or  of  deposits  or  the  volume  of  trade,  it  fol- 
lows necessarily  and  mathematically  that  the  level  of  prices 
must  double.  While,  therefore,  the  equation  of  exchange,  of 
itself,  asserts  no  causal  relations  between  quantity  of  money 
and  price  level,  any  more  than  it  asserts  a  causal  relation  be- 
tween any  other  two  factors,  yet,  when  we  take  into  account 
conditions  known  quite  apart  from  that  equation,  viz.,  that  a 
change  in  M  produces  a  proportional  change  in  M',  and  no 
changes  in  V,  V,  or  the  Q's,  there  is  no  possible  escape  from 
the  conclusion  that  a  change  in  the  quantity  of  money  (M) 
must  normally  cause  a  proportional  change  in  the  price  level 
(them's). 

While  the  equation  of  exchange  is,  if  we  choose,  a  mere 
"  truism,"  based  on  the  equivalence,  in  all  purchases,  of  the 
money  or  checks  expended,  on  the  one  hand,  and  what  they 
buy,  on  the  other,  yet  in  view  of  supplementary  knowledge  as 
to  the  relation  of  M  to  M' ',  and  the  non-relation  of  M  to  V ,  V, 
and  the  Q's,  this  equation  is  the  means  of  demonstrating  the 
fact  that  normally  the  />'s  vary  directly  as  M,  that  is,  demon- 
strating the  quantity  theory.  To  throw  away  contemptuously 
the  equation  of  exchange  because  it  is  so  obviously  true  is 
to  neglect  the  chance  to  formulate  for  economic  science 
some  of  the  most  important  and  exact  laws  of  which  it  is  ca- 
pable. 

We  may  now  restate,  then,  in  what  causal  sense  the  quan- 
tity theory  is  true.  It  is  true  in  the  sense  that  one  of  the  nor- 


210  MONEY  AND  PRICES 

mat  effects  of  an  increase  in  the  quantity  of  money  is  an  exactly 
proportional  increase  in  the  general  level  of  prices. 

I  have  no  desire,  as  some  one  has  humorously  suggested,  to 
hide  behind  an  equation,  but  I  do  find  it  necessary  to  take 
refuge  behind  my  book  on  the  Purchasing  Power  of  Money. 
So  many  new  questions  have  been  asked  that,  in  the  few  mo- 
ments at  my -disposal,  I  could  not  answer  them  all  satisfactorily. 
I  believe  they  have  all  been  answered  in  the  book  referred  to. 
For  instance,  a  chapter  has  been  devoted  to  transition  periods 
in  which  it  has  been  shown,  as  Professor  Taussig  has  sug- 
gested, that  during  transition  periods  an  increase  in  T  may 
cause  an  increase  in  M'. 

THE  TESTIMONY  OF  RICARDO 

1  Let  us  suppose  that  the  circulation  of  all  countries  were 
carried  on  by  the  precious  metals  only,  and  that  the  proportion 
which  England  possessed  were  one  million ;  let  us  further  sup- 
pose, that,  at  once,  half  of  the  currencies  of  all  countries,  ex- 
cepting that  of  England,  were  suddenly  annihilated,  would  it 
be  possible  for  England  to  continue  to  retain  the  million  which 
she  before  possessed?  Would  not  her  currency  become  rela- 
tively excessive  compared  with  that  of  other  countries?  If  a 
quarter  of  wheat,  for  example,  had  been  both  in  France  and 
England  of  the  same  value  as  an  ounce  of  coined  gold,  would 
not  half  an  ounce  now  purchase  it  in  France,  whilst  in  England 
it  continued  of  the  same  value  as  one  ounce?  Could  we  by 
any  laws,  under  such  circumstances,  prevent  wheat  or  some 
other  commodity  (for  all  would  be  equally  affected)  from  be- 
ing  imported  into  England,  and  gold  coin  from  being  exported  ? 
If  ...  the  exportation  of  bullion  were  free,  gold  might  rise 
100  per  cent. ;  and  for  the  same  reason,  if  35  Flemish  schillings 
in  Hamburgh  had  before  been  of  equal  value  with  a  pound 
sterling,  17^2  schillings  would  now  attain  that  value.  If  the 
currency  of  England  only  had  been  doubled,  the  effects  would 
have  been  precisely  the  same. 

Suppose,  again,  the  case  reversed,  and  that  all  other  cur- 

1  David  Ricardo,  Reply  to  Mr.  Bosanquet's  Practical  Observations  on 
the  Report  of  the  Bullion  Committee,  Works,  pp.  326-328.  John  Murray. 
London.  1888. 


TESTIMONY  OF  RICARDO  211 

rencies  remained  as  before,  while  half  that  of  England  was 
retrenched.  If  the  coinage  of  money  at  the  mint  was  on  the 
present  footing,  would  not  the  prices  of  commodities  be  so 
reduced  here  that  cheapness  would  invite  foreign  purchasers, 
and  would  not  this  continue  till  the  relative  proportions  in  the 
different  currencies  were  restored? 

If  such  would  be  the  effects  of  a  diminution  of  money  below 
its  natural  level,  and  that  such  would  be  the  consequences  the 
most  celebrated  writers  on  political  economy  are  agreed,  how 
can  it  be  justly  contended  that  the  increase  or  diminution  of 
money  has  nothing  to  do  either  with  the  foreign  exchanges,  or 
with  the  price  of  bullion? 

Now,  a  paper  circulation,  not  convertible  into  specie,  differs 
in  its  effects  in  no  respect  from  a  metallic  currency,  with  the 
law  against  exportation  strictly  executed. 

Supposing,  then,  the  first  case  to  occur  whilst  our  circula- 
tion consisted  wholly  of  paper,  would  not  the  exchanges  fall, 
and  the  price  of  bullion  rise  in  the  manner  which  I  have  been 
representing;  and  would  not  our  currency  be  depreciated,  be- 
cause it  was  no  longer  of  the  same  value  in  the  markets  of  the 
world  as  the  bullion  which  it  professed  to  represent?  The 
fact  of  depreciation  could  not  be  denied,  however  the  Bank 
Directors  might  assure  the  public  that  they  never  discounted 
but  good  bills  for  bona  fide  transactions  ;  however  they  might 
assert  that  they  never  forced  a  note  into  circulation;  that  the 
quantity  of  money  was  no  more  than  it  had  always  been,  and 
was  only  adequate  to  the  wants  of  commerce,  which  had  in- 
creased and  not  diminished;1  that  the  price  of  gold,  which  was 
here  at  twice  its  mint  value,  was  equally  high,  or  higher, 
abroad,  as  might  be  proved  by  sending  an  ounce  of  bullion  to 
Hamburgh,  and  having  the  produce  remitted  by  bill  payable  in 


Bank  could  not  on  their  own  principles,  then  urge  that  most  er- 
roneous opinion,  that  the  rate  of  interest  would  be  affected  in  the  money 
market  if  their  issues  were  excessive,  and  would  therefore  cause  their 
notes  to  return  to  them,  because,  in  the  case  here  supposed,  the  actual 
amount  of  the  money  of  the  world  being  greatly  diminished,  they  must 
contend  that  the  rate  of  interest  would  generally  rise,  and  they  might 
therefore  increase  their  issues.  If,  after  the  able  exposition  of  Dr.  Smith, 
any  further  argument  were  necessary  to  prove  that  the  rate  of  interest 
is  governed  wholly  by  the  relation  of  the  amount  of  capital  with  the  means 
of  employing  it,  and  is  entirely  independent  of  the  abundance  or  scarcity 
of  the  circulating  medium,  this  illustration  would  I  think  afford  it. 


212  MONEY  AND  PRICES 

London  bank  notes;  and  that  the  increase  or  diminution  of 
their  notes  could  not  possibly  either  affect  the  exchange  or  the 
price  of  bullion.  All  this,  except  the  last,  might  be  true,  and 
yet  would  any  man  refuse  his  assent  to  the  fact  of  the  cur- 
rency being  depreciated? 

Could  the  symptoms  which  I  have  been  enumerating  proceed 
from  any  other  cause  but  a  relative  excess  in  our  currency? 
Could  our  currency  be  restored  to  its  bullion  value  by  any 
other  means  than  by  a  reduction  in  its  quantity,  which  should 
raise  it  to  the  value  of  the  currencies  of  other  countries ;  or  by 
the  increase  of  the  precious  metals,  which  lower  the  value  of 
theirs  to  the  level  of  ours? 


CHAPTER  XII 
THE  GOLD  EXCHANGE  STANDARD 

It  is  an  essential  feature  of  the  gold  exchange  standard  as  it  exists  in 
the  Philippines,  for  example,  that  premiums  charged  by  the  Government 
in  Manila  for  exchange  on  New  York,  and  in  New  York  for  exchange 
on  Manila  are  fixed  at  a  point  somewhat  below  the  gold  export  points 
in  each  case.  Thus  the  would-be  exporter  of  gold  in  the  Philippines  never 
finds  it  profitable  to  ship  gold  to  New  York.  On  the  other  hand,  inter- 
national bankers  in  New  York  never  find  it  profitable  to  ship  gold  or 
currency  to  the  Philippines,  because  the  authorised  agent  of  the  Philip- 
pine government  in  New  York  always  stands  ready  to  sell  in  exchange 
for  United  States  currency,  drafts  drawn  upon  Manila  at  a  premium  less 
than  the  cost  of  shipping  gold  or  currency.  Through  a  regulation  of 
the  supply  of  silver  pesos  in  actual  circulation  in  the  Philippines  they  are 
maintained  at  a  definite  ratio  to  —  not  gold  in  the  Philippines,  but  —  gold, 
or  its  equivalent,  in  New  York.  The  way  in  which  the  supply  of  local 
currency  in  the  gold-exchange  country  is  regulated  will  be  made  clear  in 
what  follows. 

The  gold  exchange  standard  has  not  entirely  escaped  criticism.  Pro- 
fessor J.  Shield  Nicholson  has  recently  attacked  this  standard  in  India. 
(Economic  Journal,  June,  1914.)  It  is  his  contention  that  inflation  may 
occur  in  India,  if  it  has  not  already  occurred,  on  account  of  the  "  impeded 
convertibility  of  rupees  into  gold."  After  a  certain  point  is  reached  in 
the  inflation  the  decline  in  the  general  purchasing  power  of  the  rupee  must 
be  followed,  he  affirms,  by  a  specific  depreciation  as  regards  gold;  and  then 
the  main  object  of  the  plan  would  be  defeated.  He  offers  no  evidence, 
however,  that  prices  have  risen  faster  in  India  than  in  gold  standard 
countries.  With  the  exception  of  Mexico,  where  currency  conditions  have 
become  extremely  chaotic,  the  historical  material  here  reprinted  is  in  ac- 
cord with  the  recent  monetary  history  of  the  countries  under  discussion. 

1  WHEN  the  Government  of  British  India  sought,  in  1893,  to 
give  a  fixed  gold  value  to  about  £120,000,000  in  rupee  silver, 
it  undertook  an  experiment  of  great  importance  to  the  financial 
world,  and  one  which  was  naturally  viewed  in  many  quarters 
with  grave  misgivings.  The  experience  of  fifteen  years  which 
have  followed  that  experiment  has  taught  many  lessons  in 
monetary  science.  It  may,  indeed,  be  said  to  have  blazed  a 
new  path  in  the  principles  of  money  —  at  least,  in  their  prac- 
tical application.  The  effort  to  raise  the  coins  to  a  fixed  gold 
value  by  scarcity  alone  was  not  successful,  but  it  led  to  other 

1  Charles  A.  Conant,  The  Gold  Exchange  Standard  in  the  Light  of  Ex- 
perience, The  Economic  Journal,  Vol.  19,  June,  1909,  pp.  190-200. 

213 


214        THE  GOLD  EXCHANGE  STANDARD 

devices,  which,  imitated  or  improved  upon  in  Mexico,  the 
Philippines,  and  the  Straits  Settlements,  as  well  as  in  India, 
have  created  a  new  type  of  monetary  system  which  has  come 
to  bear  the  title  of  the  gold  exchange  standard. 

The  gold  exchange  standard  differs  in  several  respects  from 
the  limping  standard.  It  has  been  the  product  of  definite  pur- 
pose and  plan  in  the  Philippines  and  in  Mexico  and  to  a  cer- 
tain extent  in  India.  While  in  British  India  it  has  been,  like 
the  limping  standard,  a  compromise  with  existing  conditions, 
it  has  there,  as  elsewhere,  received  a  definite  form  and  sub- 
stance which  separated  it  from  the  limping  standard  as  evolved 
in  France  and  in  other  countries  which  found  themselves  with 
a  large  amount  of  legal-tender  silver  on  their  hands  when  the 
metal  had  fallen  below  the  official  parity.  There  are  two  other 
essential  differences  between  the  limping  standard  and  the  gold 
exchange  standard.  One  is  that  the  gold  exchange  standard 
contemplates  a  circulation  of  token  coins  of  silver  without  any 
necessary  concurrent  circulation  of  gold  or  paper.  The  other 
is  that  the  gold  exchange  standard  contemplates  definite  and 
comprehensive  measures  to  maintain  the  value  of  token  coins 
at  par  with  gold  instead  of  relying  purely  upon  custom  and 
scarcity  to  give  them  value. 

The  essential  principle  upon  which  the  exchange  standard 
has  been  established  is  that  the  value  of  money  is  governed  by 
the  law  of  supply  and  demand.  So  long  as  supply  was  indefi- 
nite and  excessive,  as  under  the  system  of  the  free  coinage  of 
silver,  there  was  no  way  of  preventing  safely  and  effectively 
the  decline  in  the  gold  value  of  the  coins  to  the  bullion  value 
of  their  silver  contents.  The  moment,  however,  that  Gov- 
ernment undertook  to  limit  the  supply  of  coins  to  the  demand 
for  them,  it  took  an  important  step  to  separate  their  value  from 
that  of  their  bullion  contents  and  to  give  them  a  value  based 
upon  the  demand  for  them  as  money  signs  required  for  carry- 
ing on  exchanges.  Strangely  enough,  while  this  principle  had 
been  in  operation  for  many  years  in  the  case  of  subsidiary 
coins,  its  bearing  upon  the  use  of  silver  in  countries  where  the 
standard  had  been  depreciating  was  not  clearly  comprehended 
until  within  recent  years.  Those  who  understood  the  principle 
doubted  its  sufficiency  to  give  a  fixed  value  to  silver  coins  as 


EXCHANGE  FUNDS  215 

the  sole  medium  of  exchange,  or  they  distrusted  the  ability  of 
any  government  to  judge  accurately  the  number  of  coins  re- 
quired. 

Upon  the  latter  point  they  would  have  been  correct  if  de- 
pendence had  been  placed  upon  guesswork  or  any  empirical 
method  of  determining  the  amount  needed.  It  remained  to 
find  the  true  solution  of  the  problem  by  so  regulating  the  quan- 
tity of  the  coins  that  it  would  respond  automatically  to  the  de- 
mands of  trade.  The  correct  method  of  doing  this  is  through 
the  system  of  exchange  funds.  As  this  system  is  operated  in 
the  Philippines,  it  is  not  possible  to  obtain  gold  coin  for  silver 
certificates  in  small  quantities;  but  it  is  possible  always  to  ob- 
tain drafts  upon  New  York  at  par,  plus  the  usual  charges  for 
exchange  between  gold  standard  countries.  These  drafts  hav^ 
to  be  purchased  with  actual  silver  coin  or  coin  certificates.  In 
either  case  the  coins  and  certificates  are,  by  the  requirements 
of  the  coinage  law,  held  in  the  Philippine  Treasury.  The  law 
does  not  permit  their  deposit  by  the  Treasury  in  current  ac- 
count at  a  bank,  which  would  turn  them  back  into  the  general 
circulation. 

For  practical  purposes  the  volume  of  currency  in  circulation 
is  contracted  to  the  same  extent  as  if  a  corresponding  amount 
of  gold  were  taken  from  the  circulation  for  export.  When 
the  current  turns  and  rates  for  money  become  high  in  the  Phil- 
ippines, Philippine  currency  can  be  released  for  local  circula- 
tion by  the  purchase  in  New  York  from  the  gold  standard  fund 
of  bills  upon  the  Philippine  Treasury.  This  rule  of  locking 
up  the  proceeds  of  the  sale  of  bills  is  not  rigidly  applied  to  the 
funds  in  New  York,  because  the  influence  of  the  Philippine 
purchases  upon  the  local  circulation  there  would  be  insignifi- 
cant. On  the  contrary,  the  Government  obtains  a  generous 
interest  rate,  which  has  at  times  been  as  high  as  4  per  cent., 
upon  the  deposit  of  Philippine  funds  with  New  York  bankers. 
During  the  stress  of  the  autumn  of  1907  considerable  transfers 
of  capital  were  made  from  Manila  to  New  York  by  means  of 
the  purchase  of  New  York  drafts  from  the  Philippine  Treas- 
ury. The  process,  often  repeated  even  under  less  serious 
pressure,  clearly  shows  that  the  monetary  system  of  the  Philip- 
pines is  linked  to  gold,  and  that  capital  can  be  freely  trans- 


2l6  THE  GOLD  EXCHANGE  STANDARD 

ferred  upon  a  gold  basis  between  Manila  and  other  mar- 
kets. 

The  experience  of  fifteen  years  since  the  free  coinage  of 
rupees  was  first  suspended  in  British  India,  of  five  years  since 
the  new  system  was  established  in  the  Philippines,  and  of 
nearly  four  years  since  it  was  in  operation  in  Mexico,  have 
settled  most  o'f  the  doubts  which  were  felt  when  the  experiment 
was  undertaken  in  India.  In  the  first  place,  it  has  been  made 
clear  that  the  value  of  the  coins  in  exchange,  as  fixed  by  law, 
has  not  been  influenced  by  variations  in  the  price  of  silver  bul- 
lion. This  statement,  of  course,  applies  only  to  one  side  of 
the  problem  —  the  fall  of  the  gold  value  of  the  silver  in  the 
coin  below  its  face  value.  It  would  not  be  possible  under  any 
system  yet  discovered,  except  such  uneconomic  devices  as  pro- 
hibiting exportation,  to  prevent  the  disappearance  of  silver 
coins  when  the  [bullion]  value  of  their  contents  rises  above 
the  legal  value  in  exchange.  Both  the  Philippines  and  Mexico 
have  faced  this  menace  to  their  monetary  circulation  since 
their  systems  were  inaugurated,  but  both  have  succeeded  in 
removing  it.  In  the  Philippines  the  contents  of  the  silver  unit 
—  the  peso  —  was  reduced  in  1906  from  about  371  grains  to 
247  grains  in  pure  silver.  The  amount  fixed  by  the  law  of  1903 
was  practically  the  same  as  the  contents  of  the  old  Mexican 
dollar.  The  adoption  of  a  coin  of  this  weight  was  caused 
partly  by  the  desire  to  avoid  the  distrust  which  some  feared 
might  arise  from  reducing  the  weight.  At  the  time  of  the 
passage  of  the  law,  moreover,  the  price  of  silver  was  nearly 
at  the  lowest  point  in  its  history,  having  touched  the  minimum 
of  21-11/16  pence  in  January,  1903,  and  being  at  an  average 
price  of  22^  pence  in  March.  The  adoption  of  so  heavy  a 
coin,  however,  was  not  in  accordance  with  the  original  recom- 
mendation made  by  the  present  writer  to  the  War  Department 
in  November,  1901.  The  weight  then  recommended  was  385 
grains,  nine-tenths  fine,  or  about  347  grains  of  pure  silver. 

In  Mexico  the  rise  of  the  silver  coins  above  the  legal  gold 
value  proved  a  blessing  in  disguise.  It  enabled  Mexico  to  go 
almost  to  an  absolute  gold  standard  by  selling  her  silver  at  a 
premium.  From  May  ist,  1905,  to  October  22nd,  1907,  the 
old  silver  piasters  were  exported  to  the  amount  of  $85,956,202, 


MEXICAN  PROFITS  217 

while  gold  coinage  was  executed  to  the  amount  of  $71,646,500 
(about  £7,200,000). l  The  gold  has  gone  chiefly  into  the  re- 
serves of.  the  banks,  which  have  in  circulation  about  $95,000,- 
ooo  in  notes.  Gold  holdings  of  the  banks,  which  were  only 
$15,832,840  in  January,  1906,  were  $54,165,483  in  October, 
1907,  while  silver  holdings  declined  over  the  same  period  from 
$49,781,155  to  $14,399,924.2  This  influx  of  gold  came  about 
because  silver  at  33  pence  was  above  the  Mexican  coinage  ratio 
of  about  32  to  i,  and  much  of  it  was  sold  by  the  Commission 
on  Money  and  Exchange  at  a  direct  profit  to  the  Mexican 
Treasury.  In  view  of  the  subsequent  fall  in  silver  below  23 
pence,  at  which  rate  Mexico  is  in  a  position  to  replenish  her 
supply  of  subsidiary  coinage,  her  statesmen  may  claim  the 
credit  of  following  the  great  rule  of  profit  in  the  commercial 
world  as  well  as  on  the  stock  exchange  —  to  sell  when  things 
are  dear  and  to  buy  when  things  are  cheap. 

The  coincidence  in  the  rise  of  silver  and  the  adoption  of  the 
Mexican  monetary  reform  in  1905  was  in  some  degree  acci- 
dental. It  facilitated  the  reform,  not  only  by  introducing  gold, 
but  by  removing  the  objections  \vhich  would  otherwise  have 
been  heard  from  the  miners  of  silver  to  the  rise  in  gold  wages 
which  would  have  accompanied  a  fixing  of  the  exchange  at  a 
point  above  the  value  of  silver  bullion.  It  was  the  intention  of 
the  Mexican  Government,  however,  to  proceed  resolutely, 
though  deliberately,  to  a  fixed  exchange,  and  they  would  un- 
doubtedly have  accomplished  this  result,  even  if  they  had  not 
been  aided  by  the  rise  in  the  value  of  silver.  Its  subsequent 
fall  has  in  no  wise  impaired  the  stability  of  the  gold  standard. 

Some  fears  were  expressed  in  the  Philippines  as  to  the 
willingness  of  the  natives  and  of  Chinese  traders  to  accept  a 
silver  coin  at  a  gold  value  fixed  by  law  which  was  obviously 
above  its  value  as  bullion.  This  difficulty  has  proved  almost 
negligible.  Silver  within  less  than  three  years  has  been  above 
33  pence  per  ounce  and  below  23  pence.  It  is  doubtful  if  the 
Government  officials  in  India  or  the  Philippines  have  so  much 
as  taken  note  of  the  daily  fluctuations  since  the  price  dropped 

1  Le  Marche  Financier  en  1907-8,  p.  711. 

2  These  figures  are  from  the  annual  budget  statements  of  the  Minister  of 
Finance. 


2l8        THE  GOLD  EXCHANGE  STANDARD 

below  the  legal  parity  of  the  coins,  and  it  is  certain  that  the 
exchange  value  of  the  coins  has  been  in  no  wise  impaired  by 
their  fall  in  bullion  value.  When  the  last  reduction  was  made 
in  the  weight  and  fineness  of  the  Philippine  coins,  lowering  by 
almost  30  per  cent,  their  silver  contents,  the  precaution  was 
taken  of  advising  the  public  by  means  of  an  official  circular, 
translated  into  the  various  languages  and  dialects  of  the 
Islands,  why  the  change  had  been  made,  and  that  it  would  not 
affect  the  exchange  value  of  the  coins.  Provincial  and  munici- 
pal treasurers  were  also  directed  to  carry  on  a  campaign  of  edu- 
cation among  the  people  by  way  of  explaining  the  character 
and  effect  of  the  change.  The  greatest  menace  to  the  value  of 
the  new  coins  lay  with  the  Chinese,  for  in  China  for  many 
hundreds  of  years  local  bankers  and  merchants  have  adhered 
to  the  rule  that  a  coin  derived  no  value  from  the  stamp,  but 
was  worth  just  what  it  would  fetch  on  the  scales.  The  Chinese 
traders  at  first  undertook  to  discriminate  in  this  manner  against 
the  new  coins  of  the  Philippines.  In  some  cases  they  refused 
to  receive  them  except  at  a  discount  varying  from  20  to  40  per 
cent.  They  also  offered  105  in  the  new  coins  for  100  in  the 
old,  evidently  in  the  hope  of  exporting  the  old  at  a  profit  while 
they  continued  to  be  worth  as  bullion  more  than  their  legal  gold 
value.  The  success  of  this  discrimination  was  local  and  ex- 
tremely short-lived.  The  first  consignment  of  the  new  coins 
reached  Manila  on  May  4,  1907,  and  when  the  Treasurer  of 
the  Islands  prepared  his  annual  report  on  October  I5th,  1907, 
he  was  able  to  make  the  following  statement  of  conditions : 

At  this  time,  October  15,  the  new  coin  is  accepted  without  ques- 
tion in  every  part  of  the  Islands,  and  no  reports  or  complaints 
have  been  received  for  the  past  two  months  as  to  discounting  it, 
and,  so  far  as  can  be  ascertained,  no  premium  is  now  paid  for  the 
old  coin.  In  fact,  the  demand  for  the  new  coin  for  exchange  pur- 
poses has  so  far  exceeded  the  supply  that  it  became  necessary  to 
withdraw  nearly  half  a  million  of  the  new  pesos  from  the  banks  to 
meet  the  requisitions  therefor  from  the  provinces. 

The  hesitation  which  prevailed,  therefore,  in  many  quarters 
in  regard  to  the  ability  of  a  government  to  overcome  the  con- 
servatism of  the  East  in  its  preference  for  coins  of  full  bullion 
value  has  not  been  warranted  by  events.  This  demonstration 


MAINTAINING  THE  STANDARD  219 

is  of  importance  if  the  exchange  standard  is  to  be  considered 
for  China.  At  present  the  Government  of  China  is  not  per- 
haps strong  enough  and  sufficiently  centralised  to  assure  its 
subjects  that  it  can  give  a  definite  gold  value  to  a  token  coin 
and  maintain  it  honestly  and  efficiently.  The  trial  of  the  sys- 
tem, however,  in  the  Philippines,  in  British  India,  and  in  the 
Straits  Settlements,  in  all  of  which  there  are  many  Chinese, 
has  probably  so  far  cleared  the  air  upon  this  point  that  the 
Chinese  Imperial  Government  would  be  able  to  establish  the 
gold  exchange  system  if  it  did  so  under  sufficient  guarantees 
to  the  financial  world  that  it  would  be  honestly  and  intelligently 
maintained. 

Next  in  importance  to  the  settlement  of  this  question  of  na- 
tive willingness  to  accept  the  new  system  may  be  considered 
the  degree  of  difficulty  in  maintaining  it.  It  is  not  surprising, 
perhaps,  that  when  it  was  proposed  in  an  incomplete  form  for 
British  India,  it  should  have  been  denounced  as  a  "  fair 
weather "  device  —  "a  leap  in  the  dark,"  which  would  not 
stand  the  test  of  business  depression,  deficient  crops,  and  an 
unfavourable  balance  of  trade.1 

The  most  serious  difficulty  which  has  been  foreseen  by 
critics  of  the  gold  exchange  system  relates  to  the  sufficiency  of 
the  exchange  funds.  Up  to  the  period  of  the  general  panic  of 
1907  and  the  crop  failure  in  India  in  the  spring  of  1908,  it 
might  fairly  be  said,  perhaps,  that  the  system  had  not  been  sub- 
jected to  any  but  "  fair  weather  "  conditions.  The  experience 
of  India,  however,  has  thrown  striking  light  upon  the  possi- 
bilities and  limitations  of  the  system  in  time  of  stress.  The 
test  in  India  has  been  of  such  magnitude,  moreover,  that  its 
results  are  much  more  conclusive  than  any  test  which  might 
have  been  afforded  in  a  smaller  country  dealing  with  a  less 
enormous  mass  of  token  coins.  If  the  test  had  come  before 
the  exchange  funds  had  acquired  a  respectable  size,  the  system 
might  have  been  allowed  to  break  down,  through  timidity  and 
delay  in  taking  proper  measures  of  protection,  and  discredit 
have  thus  been  cast  upon  it  before  it  had  been  fairly  tried. 

What  happened  in  India  was  that  the  failure  of  the  crops 

1  For  some  of  these  doubts  see  London  Bankers'  Magazine,  October,  1908, 
LXXXVI,  p.  435- 


220        THE  GOLD  EXCHANGE  STANDARD 

deprived  the  country  of  the  usual  means  of  compensating  by 
exports  the  heavy  imports  of  foreign  goods  which  had  been 
contracted  for.  It  became  necessary,  under  the  settled  princi- 
ples of  exchange,  to  find  gold  to  fill  the  gap.  Usually  the  ex- 
change account  substantially  balanced  itself  by  the  sale  in  Lon- 
don of  Council  drafts  upon  the  Indian  Government  to  obtain 
gold  to  pay  the  interest  on  the  debt  held  in  England.  These 
drafts  were  purchased  by  importers  in  London,  and  used  to 
pay  for  the  Indian  crops;  but  all  through  the  spring  of  1908 
purchasers  for  drafts  failed  to  appear,  because  there  had  been 
no  considerable  exports  of  Indian  crops  to  be  paid  for.  Hence 
Council  drafts  were  without  a  market,  and  for  a  moment  it 
seemed  that  the  link  which  bound  the  Indian  monetary  system 
to  the  gold  market  of  London  had  been  severed,  and  that  the 
silver  rupee  might  drop  as  disastrously  as  the  Mexican  dollar 
before  its  free  coinage  was  suspended.  This  would  have 
added  the  influence  of  an  appalling  disaster  to  the  burden 
already  imposed  upon  Indian  finance  by  the  failure  of  the  crops, 
for  it  would  have  compelled  the  Indian  importer  of  English 
goods  to  find  a  greatly  increased  number  of  rupees  to  meet  his 
gold  obligations  in  London.  Obviously,  it  was  a  disaster 
which,  if  it  had  occurred,  would  have  invited  the  bankruptcy 
of  the  country,  reflected  lasting  disgrace  upon  English  financial 
foresight,  and  perhaps  even  have  led  to  organised  revolt. 

The  Indian  Government  had  available  for  meeting  the  crisis 
about  £18,500,000,  principally  invested  in  securities  in  London. 
This  fund,  known  as  the  gold  standard  reserve,  was  distinct 
from  the  currency  reserve,  consisting  of  gold  received  for  cur- 
rency notes,  which  amounted  in  the  spring  of  1908  to  about 
£12,000,000.  It  was  against  the  former  fund  that  the  Indian 
Government  felt  compelled  to  offer  to  sell  exchange  in  India. 
Such  offers  were  made  for  a  time  in  limited  amounts  of  £500,- 
ooo  each,  but  they  proved  substantially  adequate  for  meeting 
the  demand,  and  by  early  summer  the  demand  fell  below  the 
supply.  The  offer  of  exchange  in  this  form  for  rupees  main- 
tained the  value  of  the  rupee  coinage,  contracted  the  amount 
of  rupees  in  circulation  in  India,  and  enabled  the  Indian  mer- 
chants to  meet  their  obligations  without  the  loss  which  they 
must  have  suffered  if  the  currency  had  been  allowed  to  depre- 


SECURITY  OF  SYSTEM  221 

ciate  in  gold  value.  The  actual  sales  of  bills  upon  the  exchange 
funds  in  London  reached,  between  March  26th  and  August 
I3th,  1908,  the  considerable  total  of  £8,058,000.  Of  this 
amount  about  £2,000,000  was  taken  from  the  currency  reserve 
in  gold,  which  was  "  earmarked  "  at  the  Bank  of  England,  in- 
cidentally affording  relief  to  the  London  money  market  which 
was  keenly  appreciated.  Most  of  the  remainder  was  obtained 
by  the  sale  of  securities  to  an  amount  which  reduced  such  hold- 
ings from  £14,019,676  on  March  3ist  to  £9,415,708  on  July 
3 1  st. 

The  test  to  which  the  Indian  system,  as  the  most  important 
example  of  the  gold  exchange  standard,  was  thus  subjected 
was  perhaps  of  a  higher  importance  than  was  realised  by  those 
in  the  thick  of  the  conflict.  It  was  plainly  intimated,  however, 
in  the  annual  report  on  financial  conditions  for  1908  that,  if 
necessary,  the  Indian  Government  would  have  issued  short- 
dated  securities  in  order  to  still  further  replenish  the  exchange 
funds  in  London.  This  would  have  been  the  true  means  of 
meeting  the  situation  if  the  existing  fund  had  been  unduly 
impaired.  The  argument  against  it  would  have  been  that  the 
demand  was  indefinite,  and  might  become  so  large  as  to  be  un- 
manageable. The  fact  that  the  demand  for  exchange  was  met 
without  the  issue  of  new  securities  and  without  trenching  upon 
the  reserve  funds  beyond  the  amount  of  £8,000,000  out  of 
£18,500,000  affords  pretty  strong  evidence  that  there  is  a  nat- 
ural limit  to  such  demands. 

It  is  in  this  principle,  that  there  is  a  natural  limit  to  the  possi- 
ble drain  upon  the  exchange  funds,  that  the  security  of  the 
new  system  lies.  ...  It  is  only  the  supply  of  local  currency 
on  the  margin  of  possible  export  demands  which  needs  to  be 
safeguarded.  The  substratum,  which  can  never  leave  the 
country  unless  under  the  influence  of  an  almost  inconceivable 
economic  cataclysm,  is  analogous  in  some  respects  to  the  "  au- 
thorised "  circulation  of  the  Bank  of  England.  It  represents 
the  irreducible  minimum  below  which  the  local  need  for  cur- 
rency can  never  fall.  If  the  supply  on  the  margin  of  the  inter- 
national exchange  movement  is  adequately  guarded,  then  the 
whole  system  is  secure.  If  it  were  conceivable  that  the  demand 
for  exchange  would  equal  the  whole  amount  of  the  local  cur- 


222        THE  GOLD  EXCHANGE  STANDARD 

rency,  or  even  the  half  of  it,  then  it  would  be  necessary  to 
maintain  exchange  funds  equal  to  the  whole  amount  of  token 
coins  or  the  half  of  them  in  order  to  insure  safety.  But  obvi- 
ously this  could  never  be  the  case. 

This  argument  against  the  exchange  standard  is  only  a  repe- 
tition of  the  dilemma  sometimes  presented  by  untrained  minds 
in  regard  to  bank-notes:  what  would  happen  if  all  the  notes 
should  be  presented  at  one  time  for  redemption?  That  ques- 
tion has  been  answered  by  banking  experience ;  the  question  in 
regard  to  the  gold  exchange  system  has  been  and  must  be  an- 
swered by  experience  in  substantially  the  same  manner.  No 
country  can  be  subjected  to  such  stress  as  to  consent  to  part 
with  its  entire  monetary  circulation,  or  even  the  half  of  it.  On 
the  contrary,  every  influence  which  tends  to  contract  the  circu- 
lation tends  to  create  a  condition  which  makes  further  contrac- 
tion more  difficult.  Rates  for  the  loan  of  money  are  affected, 
prices  of  imported  goods  are  influenced,  imports  fall  off  and 
exports  increase,  and  inevitably  in  the  modern  money  market 
local  equilibrium  is  restored,  often  with  considerable  strain, 
but  none  the  kss  without  pulling  down  the  pillars  of  the  finan- 
cial temple. 

The  experience  of  last  spring  in  India  proves  the  adequacy 
of  a  reserve  of  15  or  20  per  cent,  of  the  circulation  to  maintain 
the  steady  parity  of  a  token  coinage.  There  is  apparently  no 
evidence  that  serious  distrust  of  the  rupee  arose,  even  when 
the  Government  was  hesitating  as  to  just  what  steps  should  be 
taken  to  meet  the  demand  for  exchange.  Even  if  such  distrust 
had  arisen,  however,  it  could  have  expressed  itself  through 
financial  channels  only  by  the  demand  for  drafts  on  London. 
These  would  not  have  been  very  valuable  to  the  average  local 
tradesman  except  as  he  was  able  to  sell  them  back  again  to  the 
banks  for  the  very  rupees  which  had  aroused  his  distrust.  In 
this  respect  the  gold  exchange  standard  may  be  said  to  put  a 
brake  upon  the  disposition  to  export  currency  from  fear  alone, 
when  the  exportation  is  not  demanded  by  the  balance  of 
trade. 

If  any  mistake  was  made  in  the  management  of  the  Indian 
currency,  it  was  in  the  investment  of  too  large  a  proportion  of 
the  gold  standard  reserve  in  securities.  While  investment  in 


PHILIPPINE  PARITY  223 

securities  is  naturally  attractive  because  of  the  income  earned, 
and  while  it  is  not  subject  to  just  criticism  while  kept  within 
certain  limits,  the  possession  of  actual  gold  to  a  considerable 
amount  is  highly  desirable.  It  would  not  be  necessary,  per- 
haps, that  such  gold  should  be  "  earmarked."  If  the  Indian 
Government  had  a  large  deposit  account  in  such  an  institution 
as  the  Union  of  London  and  Smith's  Bank,  or  the  London  City 
and  Midland,  it  would  possess  for  the  purposes  of  the  Indian 
Government  the  character  of  gold.  Drafts  against  such  a  de- 
posit could  be  sold  without  the  discount  or  delay  which  might 
be  required  in  disposing  of  securities.  It  seems  highly  desira- 
ble, therefore,  in  spite  of  the  prudence  with  which  the  recent 
pressure  was  met,  that  at  least  30  or  40  per  cent,  of  the  gold 
standard  reserve  should  in  the  future  be  kept  either  in  "  ear- 
marked "  gold  or  in  the  form  of  demand  deposits. 

In  the  case  of  the  Philippine  Islands  the  reserve  is  not  "  ear- 
marked," but  is  at  present  entirely  in  the  form  of  deposits 
\vith  New  York  bankers.  The  problem  in  the  Philippines  is 
really  child's  play  compared  to  that  in  British  India.  The  en- 
tire circulation  of  the  Philippine  Islands  is  about  40,000,000 
pesos  (£4,000,000),  against  which  a  large  reserve  has  accumu- 
lated as  the  result  of  the  recoinage  at  a  reduced  rate  as  well 
as  by  the  profits  on  the  original  coinage.  It  is  hardly  con- 
ceivable that  an  emergency  would  arise  which  would  impair 
this  reserve;  but  if  this  should  occur,  the  scratch  of  a  pen  in 
Washington  would  remedy  the  situation.  This  would  be  ac- 
complished by  depositing  gold  or  its  equivalent  in  the  exchange 
fund  in  New  York  to  the  credit  of  the  war  ^nd  navy,  and  plac- 
ing an  equivalent  amount  of  local  currency  at  the  command  of 
the  military  forces  in  the  Philippines.  Such  a  deposit  would 
operate  to  increase  the  resources  at  the  command  of  military 
disbursing  officers  in  the  Islands  without  increasing  the  amount 
actually  in  circulation  until  the  occasion  arose  to  disburse  it. 
The  Panama  currency  has  been  steadily  maintained  at  par  by 
friendly  interchanges  of  this  sort,  even  with  a  very  insignificant 
official  exchange  fund.  No  Governor  of  the  Philippines, 
therefore,  need  have  any  fear  of  his  ability  to  maintain  the 
parity  of  the  Philippine  coinage. 

Whether  the  exchange  standard  would  stand  the  strain  of  a 


224        THE  GOLD  EXCHANGE  STANDARD 

great  war  is  yet  to  be  subjected  to  practical  test.1  It  may  be 
said,  however,  that  its  capacity  to  meet  such  a  test  would  run 
upon  all  fours  with  the  capacity  of  any  monetary  system  which 
does  not  consist  exclusively  of  gold  coin.  The  experience  of 
France  in  the  war  with  Prussia  seemed  to  justify  the  suspension 
of  specie  payments  for  the  purpose  of  husbanding  the  national 
stock  of  gold.  The  history  of  the  Spanish  exchange,  where 
the  coins  have  followed  the  value  of  the  bank-notes  instead  of 
that  of  silver  bullion,  is  another  case  in  point.  Both  Russia 
and  Japan,  however,  in  the  war  of  1904-5,  succeeded  in  main- 
taining complete  convertibility  of  their  bank-notes.  There  is 
no  reason  why  the  gold  exchange  standard  should  not  be  suc- 
cessfully maintained  so  long  as  the  country  where  it  was  estab- 
lished retained  its  national  independence  and  pursued  a  sound 
financial  policy.  The  issue  of  large  amounts  of  debt  would 
not  in  itself  impair  the  stability  of  the  standard,  unless  the  Gov- 
ernment, in  order  to  obtain  gold,  ravished  the  exchange  funds 
in  financial  centres.  The  questions  involved  would  be  sub- 
stantially the  same  as  those  involved  in  maintaining  the  parity 
of  bank-notes  or  paper  money:  first,  the  disposition  of  the 
Government  to  maintain  its  credit;  secondly,  the  resources 
which  the  Government  was  able  to  command.  Without  either 
good  intentions  or  monetary  resources,  the  monetary  system, 
along  with  the  fiscal  system,  would  break  down.  It  is  not  ap- 
parent, however,  that  a  country  operating  upon  the  gold  ex- 
change system  would  find  any  greater  difficulty  in  maintaining 
the  system  than  the  Bank  of  Japan  had  in  maintaining  the  con- 
vertibility of  its  notes  during  the  war  with  Russia. 

If  there  were  a  disposition  in  time  of  war  to  transfer  capital 
abroad  by  excessive  demands  upon  the  exchange  funds,  it  could 
be  counteracted  in  three  ways.  One  would  be  the  automatic 
influence  of  the  deficiency  of  currency  which  would  arise  at 
home.  Another  would  be  the  issue  of  loans  abroad,  from 
which  exchange  demands  could  be  met.  A  third  would  be  the 
deliberate  elevation  by  a  small  percentage  of  the  charge  for 
exchange.  This  would  amount  to  a  slight  depreciation  in  the 

1  Throughout  August,  1914,  while  sterling  rates  in  other  countries  rose 
to  unprecedented  heights,  India  succeeded  in  maintaining  rates  on  London 
in  the  neighborhood  of  the  gold  export  point  —  a  striking  testimony  to  the 
soundness  of  the  Indian  arrangements. —  EDITOR. 


ADVANTAGES  225 

currency,  but  if  kept  within  prudent  bounds,  it  would  probably 
permit  the  maintenance  of  an  adequate  circulation  without  dis- 
turbance to  local  prices  and  without  even  a  theoretical  depres- 
sion below  the  2  or  2.^/2  per  cent,  which  affected  the  notes  of 
the  Bank  of  France  in  the  war  of  1870. 

The  gold  exchange  system  may  indeed  be  said  to  be  an  ex- 
tension of  the  bank-note  system  to  token  coins.  The  token 
coin  is,  in  effect,  a  metallic  bank-note,  whose  maintenance  at 
gold  par  is  subject  to  the  rules  of  sound  banking.  Its  advan- 
tages over  the  bank-note  in  undeveloped  countries  are  that  it 
conforms  to  a  strong  prejudice  in  favour  of  "  hard  money," 
not  subject  to  the  vicissitudes  of  tropical  climes,  and  that  the 
output  can  be  more  safely  regulated,  where  new  coins  are  issued 
only  for  gold,  than  where  a  bank  may  increase  its  note  issues 
to  take  over  assets  of  speculative  or  doubtful  character.  In 
the  advanced  countries,  with  a  highly  organised  credit  system, 
gold,  and  gold  alone,  is  the  proper  form  of  full  legal-tender 
coin ;  but  in  the  less  advanced,  countries  of  the  Orient  silver 
token  coins  have  the  advantage  that  they  conform  in  size  and 
denominations  to  the  small  scale  of  local  transactions,  that 
they  are  not  so  rapidly  absorbed  by  hoarding,  and  that  their 
very  non-exportability  enables  the  Government  to  keep  in  cir- 
culation a  quantity  of  currency  which  might  under  a  different 
system  be  drained  away  to  richer  countries,  and  leave  the  com- 
munity denuded  of  an  adequate  medium  for  carrying  on  ex- 
changes. 

OBJECTIONS  TO  THE  GOLD-EXCHANGE  STANDARD  FOR  THE 
STRAITS  SETTLEMENTS  ANSWERED 

1.  .  .  the  establishment  of  the  gold  standard  in  the  Straits 
Settlements  ...  in  the  spring  of  1903  .  .  .  provided  for  the 
recoinage  of  the  British  and  Mexican  dollars  then  circulating 
in  the  Malay  Peninsula  into  new  Straits  Settlements  dollars 
...  of  the  same  weight  and  fineness  as  the  British  dollar,  and 
for  the  subsequent  raising  of  the  value  of  these  new  dollars 
to  an  unannounced  gold  par  by  means  of  limiting  the  supply, 

1  E.  W.  Kemmerer,  A  Gold  Standard  for  the  Straits  Settlements  II'., 
Political  Science  Quarterly,  Vol.  XXI,  No.  4,  p.  663,  678-680. 


226        THE  GOLD  EXCHANGE  STANDARD 

in  accordance  with  the  principle  by  which  India  raised  the  gold 
value  of  the  rupee.  .  .  . 

The  objections  urged  to  the  adoption  of  the  gold-exchange 
standard  are  [were]:  (i)  That  it  would  unduly  interfere 
with  the  [foreign  exchange]  business  of  the  banks.  (2) 
That  it  would  encourage  banks  to  work  on  dangerously  low 
cash  balances,  knowing  as  they  would  that  they  could  obtain 
dollars  of  the  Government  on  a  moment's  notice  by  the  pur- 
chase of  cable  transfers  on  Singapore  from  the  crown  agents 
for  the  colonies  in  London.  (3)  That  there  would  be  dan- 
ger of  the  Government's  notes  [a  part  of  the  circulating  me- 
dium] depreciating  unless  they  were  redeemable  in  gold  in 
the  country  itself.  (4)  That  the  monetary  circulation  of 
the  Straits  Settlements  was  too  small  to  make  the  plan  feasible 
there.  (5)  That  the  plan  would  require  a  larger  reserve 
fund  than  would  otherwise  be  necessary,  because  the  Govern- 
ment would  be  compelled  to  keep  a  reserve  both  in  London  and 
Singapore;  and  that  in  each  place  the  reserve  would  have  to 
be  large,  because  drafts  on  the  fund  through  the  sale  of  tele- 
graphic transfers  would  not  give  the  Government  any  such 
warning  in  advance  of  the  demands  liable  to  be  made  as  would 
enable  it  to  replenish  the  reserve. 

The  above  arguments,  all  of  which  were  urged  upon  the 
writer  either  by  officials  or  business  men  in  the  Straits  Settle- 
ments, do  not  appear  to  be  conclusive  for  the  following  reasons, 
which  may  conveniently  be  stated  in  the  same  order  as  the 
objections.1  (i)  If  the  rates  for  the  sale  of  government 
drafts  were  fixed  at  the  "  gold  points,"  as  they  presumably 
would  be  under  the  gold-exchange  standard,  and  if  only  drafts 
of  large  amounts  were  to  be  sold  by  the  Government,  redemp- 
tion by  the  sale  of  drafts  would  not  interfere  appreciably  more 
with  the  business  of  the  banks  than  would  redemption  in  coin. 
Under  these  circumstances  the  banks  themselves  would  be  the 
principal  purchasers  of  government  drafts,  and  such  drafts 
would  be  purchased  and  forwarded  merely  in  lieu  of  the  ship- 
ment of  sovereigns.  (2)  The  sale  of  telegraphic  transfers, 

1  The  answers  given  to  the  objections  just  stated  have  been  confirmed 
and  strengthened  by  the  actual  operation  of  the  gold-exchange  standard 
as  later  adopted  by  the  Straits  Settlements.—  EDITOR. 


OBJECTIONS  ANSWERED  227 

while  desirable  in  the  interest  of  currency  elasticity,  is  by  no 
means  a  necessary  feature  of  the  gold-exchange  standard.  If 
the  Government  were  opposed  to  making  a  minimum  legal  re- 
serve requirement  of  banks,  it  could  limit  its  sales  of  drafts  to 
demand  drafts  or  even,  if  need  be,  to  short-time  drafts.  (3) 
If  government  notes  were  redeemable  in  silver  dollars  on  de- 
mand, and  if  the  silver  dollars  were  redeemable  in  gold  ex- 
change on  demand,  depreciation  would  be  impossible  in  a  coun- 
try where  the  people  have  the  confidence  in  the  Government 
which  they  have  in  the  Straits  Settlements.  (4)  The  system 
of  the  gold-exchange  standard  is  better  suited  to  a  country  with 
a  small  circulation  than  to  one  with  a  large  circulation.  It  is 
evidently  easier  to  maintain  a  small  reserve  abroad  than  a 
large  one  and  the  operations  with  a  small  reserve  are  less  dis- 
turbing to  the  money  market  of  the  financial  center  in  which 
the  reserve  is  located.  (5)  It  is  not  probable  that  the  Straits 
Settlements  would  require  so  large  a  reserve  under  the  gold-ex- 
change standard  as  it  will  under  the  system  to  be  adopted. 
Under  either  system  it  would  need  a  sovereign  reserve  and  a 
dollar  reserve.  Under  the  system  to  be  adopted  both  reserves 
will  be  located  in  Singapore ;  under  the  gold-exchange  standard 
the  dollar  reserve  would  be  located  in  Singapore  and  the  sover- 
eign reserve  in  London.  The  sale  of  cable  transfers  is  not  a 
necessary  part  of  the  system,  as  above  pointed  out ;  and,  even  if 
it  were,  the  movement  of  market  rates  of  exchange  would  ordi- 
narily give  ample  warning  of  a  demand  for  dollar  drafts  or 
sovereign  drafts.  Emergency  cases,  if  such  should  arise,  could 
be  met  through  the  temporary  transfer  of  funds  to  the  gold 
reserve  from  the  security  portion  of  the  note  guarantee  fund, 
or  through  the  transfer  of  dollars  to  the  credit  of  the  home 
government  in  Singapore  in  exchange  for  an  equivalent  amount 
of  sovereigns  placed  to  the  credit  of  the  Straits  government  in 
London  ...  A  prolonged  and  severe  drain  upon  the  reserve 
fund,  wrhich  in  a  country  like  the  Straits  Settlements  would  be 
an  extremely  improbable  contingency  if  the  Government  with- 
drew from  circulation  dollars  presented  in  the  purchase  of 
government  drafts,  could  of  course  always  be  met  by  the  for- 
ward sale  on  the  London  silver  market  of  the  redundant  dol- 
lars piling  up  in  the  Government's  dollar  reserve  in  Singapore. 


228        THE  GOLD  EXCHANGE  STANDARD 

The  gold-exchange  standard  would  probably  enable  the  coun- 
try to  get  along  with  a  smaller  gold  reserve  than  will  the  system 
to  be  adopted,  inasmuch  as  it  would  keep  gold  coins  out  of  cir- 
culation and  the  demands  upon  it  would  be  limited  to  the  re- 
quirements of  meeting  foreign  trade  balances  —  the  only  mone- 
tary use  to  which  the  dollars  could  not  be  applied.  The  Straits 
Settlements,  inasmuch  as  it  is  a  country  for  whose  trade  re- 
quirements silver  coins  are  better  adapted  than  gold,  and  a 
country  which  is  anxious  to  maintain  its  reserve  at  as  small 
an  expense  as  possible,  would  in  fact  seem  to  be  a  place  pecu- 
liarly adapted  to  the  gold-exchange  standard.  The  premiums 
which  the  Government  would  realize  on  its  sale  of  exchange, 
together  with  the  interest 'it  would  obtain  on  that  part  of  its 
reserve  deposited  abroad,  would  doubtless  yield  sufficient  profit, 
as  in  the  Philippines,  to  pay  the  expenses  of  administering  the 
currency  system  and  to  provide  in  addition  a  substantial  annual 
increment  to  the  gold  reserve. 


CHAPTER  XIII 
A  PLAN  FOR  A  COMPENSATED  DOLLAR 

1  IN  the  Purchasing  Power  of  Money  (1911)  I  sketched  a 
plan  for  controlling  the  price  level,  i.  e.,  standardizing  the  pur- 
chasing power  of  monetary  units.  This  plan  was  presented 
more  briefly,  but  in  more  popular  language,  before  the  Inter- 
national Congress  of  Chambers  of  Commerce,  at  Boston,  Sep- 
tember, 1912.  The  details  were  most  fully  elaborated  in  the 
Quarterly  Journal  of  Economics,  February,  1913.  Following 
these  and  various  other  presentations  of  the  subject,  especially 
the  discussion  at  the  meeting  of  the  American  Economic  Asso- 
ciation in  December,  1912,  the  plan  was  widely  criticized  by 
economists,  both  favorably  and  unfavorably,  as  well  as  by  the 
general  public. 

On  the  whole  the  plan  has  been  received  with  far  more  fa- 
vor than  I  had  dared  to  hope  and  even  the  adverse  criticism 
has  usually  been  tempered  by  a  certain  degree  of  approval. 

The  object  of  the  present  paper  is  briefly  to  state  the  plan 
and  to  answer  the  more  important  and  technical  objections 
which  have  been  rafsed.  Answers  to  the  more  popular  objec- 
tions, omitted  from  this  article  through  lack  of  space,  will  ap- 
pear in  a  book,  Standardizing  the  Dollar ',  which  I  hope  to  pub- 
lish in  1915. 

I  shall  begin  with  a  skeleton  statement  of  the  plan ;  space  is 
lacking  for  more.  In  brief,  the  plan  is  virtually  to  vary  each 
month  the  weight  of  the  gold  dollar,  or  other  unit,  and  to  vary 
it  in  such  a  way  as  to  enable  it  always  to  have  substantially  the 
same  general  purchasing  power.  The  word  "  virtually "  is 
emphasized,  lest,  as  has  frequently  happened,  any  one  should 
imagine  that  the  actual  gold  coins  were  to  be  recoined  at  a  new 

1  Adapted  from  Irving  Fisher,  Objections  to  a  Compensated  Dollar 
Answered,  reprint  from  The  American  Economic  Review,  Vol.  IV,  No. 
4,  December,  1914. 

229 


230  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

weight  each  month.  The  simplest  disposition  of  existing  gold 
coins  would  be  to  call  them  in  and  issue  paper  certificates  there- 
for. The  virtual  gold  dollar  would  then  be  that  varying  quan- 
tum of  gold  bullion  in  which  each  dollar  of  these  certificates 
could  be  redeemed.  The  situation  would  be  only  slightly  dif- 
ferent from  that  at  present,  since  very  little  actual  gold  now 
circulates;  instead,  the  public  uses  gold  certificates,  obtained 
on  the  deposit  of  gold  bullion  at  the  Treasury,  and  redeemable 
in  gold  bullion  at  the  Treasury  at  the  rate  of  25.8  grains,  nine- 
tenths  fine,  per  dollar.  The  only  important  change  which 
would  be  introduced  by  the  plan  is  in  the  redemption  bullion ; 
we  would  substitute  for  25.8  a  new  figure  each  month.  The 
gold  miner,  or  other  owners  of  bullion,  would,  just  as  now, 
deposit  gold  at  the  United  States  Mint  or  Treasury  and  receive 
paper  representatives,  while  the  jeweler,  exporter,  and  other 
holders  of  these  certificates  would,  just  as  now,  present  them 
to  the  Treasury  when  gold  bullion  was  desired. 

There  would  also  be  a  small  fee  or  "  brassage,"  of,  say,  I 
per  cent,  for  "  coinage,"  i.  e.,  for  depositing  the  bullion  and 
obtaining  its  paper  circulating  representative.  In  other  words, 
the  Government  would  buy  gold  bullion  at  I  per  cent  less  than 
it  sold  it.  This  pair  of  prices,  for  buying  and  selling,  would 
be  shifted  in  unison,  both  up  or  both  down,  from  month  to 
month,  it  being  provided,  however,  that  no  single  shift  should 
exceed  I  per  cent.,  a  figure  equal  to  the  amount  by  which  the 
two  differ.  The  object  of  this  proviso  is  to  prevent  specula- 
tion in  gold. 

To  determine  each  month  what  the  pair  of  prices  should  be, 
or,  what  is  practically  the  same  thing,  to  determine  what 
amount  of  gold  bullion  should  be  received  and  paid  out  in  ex- 
change for  paper,  recourse  would  be  had  to  an  official  index 
number  of  prices.  If,  in  any  month,  the  index  number  is 
found  to  deviate  from  the  initial  par,  the  weight  of  bullion  in 
which  it  shall  be  redeemable  the  next  month  is  to  be  corrected 
in  proportion  to  this  deviation.  Thus,  the  depreciation  of  gold 
would  lead  to  a  heavier  virtual  dollar ;  and  an  appreciation,  to 
a  lighter  virtual  dollar. 

There  are,  of  course,  other  details  and  possible  variants  of 
the  plan,  some  of  which  will  be  referred  to  later  when  neces- 


OBJECTIONS  ANSWERED  231 

sary.     The  objections  to  the  plan  are  classified  under  the  fol- 
lowing heads : 

1.  "  The  plan  assumes  the  truth  of  the  quantity  theory  of 
money"     There  is  nothing  whatever  in  the  plan  itself  which 
could  not  be  accepted  by  those  who  reject  the  quantity  theory 
altogether.     On  the  contrary,  the  plan  will  seem  simpler,  1 
think,  to  those  who  believe  a  direct  relationship  exists  between 
the  purchasing  power  of  the  dollar  and  the  bullion  from  which 
it  is  made  —  without  any  intermediation  of  the  quantity  of 
money  —  than  it  will  seem  to  quantity  theorists. 

2.  "  It  contradicts  the  quantity  theory."     This  objection, 
the  opposite  of  that  above,  is  raised  by  some,  who,  like  Pro- 
fessor Boissevain,  believe  in  the  quantity  theory,  but  imagine 
that  the  operation  of  the  plan  could  not  affect  the  quantity  of 
money  at  all  (or  would  not  affect  it  to  the  degree  needed). 
But  evidently  an  increase  in  the  weight  of  the  virtual  dollar, 
i.  c.,  a  reduction  in  the  price  of  gold  bullion,  would  tend  to 
contract  the  currency,  by  diverting  gold  from  the  mint  into 
the  arts ;  because  its  reduced  price  would  cause  an  increased 
demand  and  consumption.     A  decrease,  of  course,  would  have 
the  opposite  effect. 

3.  "  It  might  aggravate  the  evils  it  seeks  to  remedy."     This 
objection,  raised  by  Professor  Taussig  and  a  few  others,  is 
based  on  the  preceding.     It  is  claimed  that  an  increase  in 
coined  money  may  take  place  for  years  "  without  visible  effect 
on  prices ;  then  comes  a  flare-up,  so  to  speak."     I  doubt  if  Pro- 
fessor Taussig  meant  the  first  half  of  this  statement  to  be  quite 
so  strong.     The  evidence  only  justifies  the  statement  that  the 
rise  is  slow  at  first  and  rapid  later  while  similarly  the  effect 
of  a  scarcity  of  money  is  slow  at  first  and  rapid  later.     Pro- 
fessor Taussig  then  proceeds  to  apply  the  same  idea  to  my 
plan: 

The  cumulative  consequence  would  be  like  the  cumulative  con- 
sequence of  a  long  continued  decline  in  gold  production.  After 
a  season  or  two  of  declining  bank  reserves,  tight  money,  and  so  on, 
a  sudden  collapse  might  be  occasioned,  and  apparently  caused,  by 
the  announcement  of  some  particular  seigniorage  adjustment.  Then 
there  might  be  a  decline  in  prices  much  greater  than  in  proportion 
to  the  bullion  change. 


232  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

But  the  working  of  the  compensated  dollar  would  not  be  in 
the  least  analogous  to  the  operation  of  gold  inflation  or  con- 
traction, even  as  Professor  Taussig  supposes  it.  The  plan 
always  works  cumulatively  toward  par,  never  cumulatively 
away  from  par.  One  often  sees  a  wagon  with  its  wheels  on 
a  street-railway  track  having  some  difficulty  getting  off;  the 
front  wheels  have  to  be  turned  at  a  large  angle  before  they  are 
forced  out  of  their  grooves;  then  of  a  sudden  they  jump  away. 
This  is  analogous  to  the  delayed  "  flare-up  "  of  prices  which 
Professor  Taussig  supposes  under  the  influence  of  a  long  con- 
tinued decline  or  increase  in  the  gold  supply.  But  if  the  driver 
instead  of  trying  to  turn  out  is  trying  to  keep  the  wagon  on 
the  track  he  will  pull  the  horse  back  at  every  tendency  to  turn 
to  the  right  or  left.  The  more  the  horse  turns  to  the  right 
the  harder  will  the  driver  endeavor  to  turn  him  to  the  left. 
Clearly  the  effect  of  the  driver's  efforts  will  be  to  avert  or  de- 
lay, not  to  aggravate  or  hasten,  any  jumping  out  of  the 
grooves  which  other  causes  may  tend  to  produce. 

In  other  words,  if  it  takes  as  much  time  as  Professor  Taus- 
sig fears  for  a  pressure  on  prices  to  move  them,  then  so  much 
the  more  certain  is  it  that,  under  the  plan,  deviations  from  par, 
though  they  may  be  persistent,  cannot  be  either  rapid  or  wide. 
A  long  continued  small  deviation  gives  plenty  of  time  for  the 
counter  pressure  exerted  by  the  compensating  device  to  ac- 
cumulate and  head  off  any  wide  deviation. 

Suppose  that,  following  Professor  Taussig's  ideas,  some 
cause  such  as  an  increase  of  gold  production  would,  in  the  ab- 
sence of  the  compensated  dollar  plan,  gradually  lift  the  price 
level  as  follows:  during  the  first  year,  not  at  all;  during  the 
second  year,  i  per  cent. ;  during  the  third  year,  2  per  cent. ; 
after  which  would  come  a  "  flare-up  "  of  10  per  cent.  We 
may  suppose  then  that,  if  the  plan  were  in  operation  during 
the  first  year,  there  being  no  deviation  visible,  there  would  be 
no  change  in  the  weight  of  the  dollar.  After  the  first  month 
of  the  second  year  when  prices  were  I  per  cent,  above  par,  the 
weight  of  the  dollar  would  according  to  the  plan  be  raised  i 
per  cent.  If  this  were  unavailing,  so  that  in  the  second  month 
the  deviation  were  still  i  per  cent,  the  weight  of  the  dollar 
would  be  again  increased  i  per  cent.  Every  month,  as  long 


OBJECTIONS  ANSWERED  233 

as  the  deviation  of  i  per  cent,  lasts,  the  weight  of  the  dollar 
would  receive  an  additional  i  per  cent.  Unless  some  effect 
were  produced  on  the  supposed  original  schedule  of  deviations, 
the  weight  of  the  dollar  of  the  second  year  would  be  increased 
12  per  cent,  and  by  the  end  of  the  third  year  by  24  per  cent, 
more,  or  36  per  cent,  in  all.  But  it  is  clear  that  by  this  time, 
with  so  swollen  a  dollar,  the  "  flare-up  "  scheduled  for  the 
fourth  year  could  not  occur,  but  that  a  counter  movement 
would  set  in  —  in  fact,  would  have  set  in  long  before  the  dollar 
became  so  heavily  counterpoised.  Nor  could  the  result,  of  the 
counterpoise,  even  if  so  heavy,  be  to  swing  suddenly  prices  far 
below  par.  Prices  would,  by  hypothesis,  yield  slowly  and 
again  give  time  for  taking  the  counterpoise  off.  If  the  price 
level  sank,  say  to  i  per  cent,  below  par  for  six  months,  then  to 
2  per  cent,  for  another  six  months  and  to  3  per  cent,  in  the 
next  six  months,  evidently  the  entire  36  per  cent,  would  be 
taken  off  in  eighteen  months  (since  1X6+2X6+3X6^36). 
The  compensating  device  is  thus  similar  to  the  governor  on  a 
steam  engine.  It  is  the  balance  wheel  that  is  largest  and  hard- 
est to  move  which  is  the  most  easily  controlled  by  the  gover- 
nor. So  if  the  "  flare-up  "  theory  is  true,  the  system  will  work 
more  perfectly  than  if  it  were  not  true. 

4.  "  It  would  not  work  unless  every  single  mint  in  the  world 
employed  it."  This  is  an  error.  Although  it  could  be  easily 
shown  to  be  politically  inadvisable  for  one  nation  alone  to 
operate  the  plan,  this  would  not  be  economically  impossible. 
Those  who  hold  the  contrary  are  deceived  by  the  term  "  mint 
price."  They  reason  that  our  mint  price  ($18.60  an  ounce  of 
gold,  9/10  fine)  and  England's  mint  price  (£3  ifs.  lo^d.  for 
gold  11/12  fine)  are  now  "the  same,"  and  that,  consequently, 
if  our  price  were  lowered  i  per  cent.,  i.  c.,  to  $18.41,  while 
the  English  price  remained  unchanged,  all  our  gold  would  be 
taken  to  England  to  take  advantage  of  the  "  higher  "  price 
there.  But  these  comparisons  between  English  and  American 
prices  are  based  on  the  present  "  par  of  exchange  "  ($4.866  of 
American  money  for  the  English  sovereign) ;  which  par  of 
exchange  is  in  turn  based  on  the  relative  weights  of  the  dollar 
and  the  sovereign.  As  soon  as  our  dollar  were  made  i  per 
cent,  heavier,  not  only  would  the  new  American  mint  price 


234  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

go  down  i  per  cent.,  but  the  par  of  exchange  would  also  go 
down  i  per  cent.,  to  $4.82.  Consequently,  the  new  mint  price 
of  $18.41,  although  in  figures  it  is  lower  than  the  old,  yet, 
being  in  heavier  dollars,  would  still  be  "  the  same "  as  the 
English  mint  price  of  £3  17.?.  iQ^/zd.  This  sameness  of  mint 
price  as  between  the  two  countries  means  at  bottom  merely 
that  an  ounce  of  gold  in  America  is  equivalent  to  an  ounce  of 
gold  in  England. 

It  is  true  that  each  increase  in  the  weight  of  the  virtual  dol- 
lar in  America  —  in  other  words,  each  fall  in  the  official 
American  price  of  gold  —  would  at  first  discourage  the  mint- 
ing of  gold  in  America.  The  miner  would  at  first  send  his 
gold  to  London,  where  the  mint  price  was  the  same  as  for- 
merly, and  realize  by  selling  exchange  on  the  London  credit 
thus  obtained.  But  the  rate  of  exchange  would  soon  be  af- 
fected through  these  very  operations,  by  which  he  attempted 
to  profit,  and  his  profit  would  soon  be  reduced  to  zero;  the 
export  of  gold  to  England  would  increase  the  supply  of  bills 
of  exchange  in  America  drawn  on  London  and  lower  the  rate 
of  exchange  until  there  would  be  no  longer  any  profit  in  send- 
ing gold  from  the  United  States  to  England  and  selling  ex- 
change against  it.  When  this  happened  it  would  be  as  profit- 
able to  sell  gold  to  American  mints  at  $18.41  per  ounce  as  to 
ship  it  abroad;  and  $18.41  in  America  would  be  the  exact 
equivalent  at  the  new  par  of  exchange  ($4.82)  of  the  English 
mint  price  of  £3  17^.  ic^rf. 

5.  "  The  system  would  be  destroyed  by  war."  Professor 
Taussig  fears  that  if  money  were  stabilized,  the  system  would 
itself  be  upset  by  war.  "  Any  war  would  put  an  end  to  it." 
To  this  I  would  reply:  first,  that  if  war  did  put  an  end  to  it 
the  system  would  do  good  so  long  as  it  lasted  and  its  discon- 
tinuance would  do  no  more  harm  than  the  existence  of  our 
present  unscientific  system  is  doing  at  all  times;  secondly,  I 
do  not  see  any  reason  for  thinking  that  war  would  put  an 
end  to  it. 

Possibly  Professor  Taussig  has  in  mind  the  first  form  in 
which  I  explained  the  plan,  vis.,  in  my  book,  The  Purchasing 
Power  of  Money.  In  that  form  one  country  was  to  serve  as 
a  centre  and  all  other  countries  were  to  have  the  gold  exchange 


OBJECTIONS  ANSWERED  235 

standard  in  terms  of  gold  reserves  in  the  central  country,  just 
as  now  the  Philippines  have  a  gold  exchange  standard  with 
reference  to  the  United  States  and  India  with  reference  to 
England.  Professor  Taussig's  objection  would  undoubtedly 
apply,  to  some  extent,  in  cases  where  the  plan  was  carried  out 
through  the  gold  exchange  mechanism.  But  where  the  sys- 
tem was  independently  established  in  each  country  simply 
parallel  to  the  systems  in  other  countries,  there  would  be  no 
more  need  for  its  abandonment  in  case  of  war  than  for  the 
abandonment  now  by  Germany  of  the  gold  standard  because 
England,  its  enemy,  has  the  gold  standard  also.  We  know, 
of  course,  that  in  time  of  war,  the  gold  standard  is  often  tem- 
porarily abandoned  in  favor  of  a  paper  standard;  and  the 
new  proposal  would  not  escape  such  a  difficulty.  This,  how- 
ever, would  not  be  due  to  the  international  character  of  the 
plan,  but  to  the  exigencies  of  war. 

6.  "  The  multiple  standard  is  not  ideal.  Especially  is  it 
faulty  when  the  cause  of  price  movements  is  entirely  a  matter 
of  the  abundance  or  scarcity  of  goods  in  general."  Those 
who  hold  this  objection  point  out  that  an  ideal  standard  would 
not  be  one  which  always  smooths  out  the  price  level  but  one 
which  discriminates  and  leaves  unchanged  such  rises  and  falls 
as  are  due  to  general  scarcity  and  abundance  of  goods.  There 
is  much  to  be  said  in  favor  of  such  discrimination  as  an  ideal. 
It  must  be  admitted  that  the  compensated  dollar  plan  would 
not  discriminate  between  changes  in  the  price  level  due  to  the 
scarcity  or  abundance  of  goods  in  general  and  those  due  to 
changes  in  money  and  credit.  It  must  be  further  admitted 
that  a  theoretically  ideal  standard  would  take  some  account 
of  this  distinction.  But  the  compensated  dollar  plan  does  not 
claim  to  be  ideal.  The  plan  would  simply  correct  the  gold 
standard  to  make  it  conform  to  a  multiple  commodity  stand- 
ard. It  does  not  pretend  to  correct  the  multiple  commodity 
standard  to  make  it  conform  to  some  "  absolute  "  standard 
of  value. 

Such  an  ideal  standard  is  as  unattainable  as  is  absolute 
space.  Changes  in  relative  value  indicate  change  in  absolute 
value,  either  of  goods  or  of  money;  but  it  is  not  possible  for 
us  to  know,  except  in  a  general  way,  how  much  of  the  abso- 


236  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

lute  change  is  in  goods  and  how  much  in  the  dollar.  On  gen- 
eral principles  we  may  be  assured  that  the  absolute  change  is 
wholly  or  mostly  in  the  dollar.  We  economists  in  our  meas- 
urements of  value  are  in  much  the  same  predicament  as  the 
astronomers.  Our  economical  "  fixed  stars  "  are  fixed  only 
in  a  relative  sense.  We  cannot  measure  the  empty  spaces  of 
absolute  value,  but  can  only  express  values  in  terms  of  visible 
goods,  the  general  average  of  which  is  the  nearest  approach 
to  absolute  invariability  we  can,  in  practice,  reach. 

But  if  it  were  possible  to  measure  absolute  values  to  our  uni- 
versal satisfaction,  in  terms,  say,  of  "  marginal  utility,"  or  of 
"  disutility  of  labor,"  or  of  anything  else,  there  are  no  statis- 
tics by  which  we  can  realize  such  a  standard  in  practice.  The 
only  readily  available  statistics  by  which  we  can  correct  our 
present  standard  are  price  statistics  from  the -great  markets. 
We  can,  by  index  numbers  based  on  these  price  statistics,  trans- 
late from  gold  into  commodities,  but  as  yet  we  cannot  translate 
from  commodities  into  any  ideal  or  absolute  standard. 

If  I  were  treating  of  the  problem  of  an  ideal  standard  of 
value,  I  think  I  should  be  inclined  to  agree  with  Professor 
Marshall  that  a  standard  that  represents  a  gradually  descend- 
ing scale  of  prices  to  keep  pace  with  the  "  real "  cheapening 
improvements  in  industrial  processes  is  better  than  one  which 
represents  an  absolute  constancy  of  prices.  But  it  would  be 
quite  impracticable  to  discover  the  exact  rate  of  fall  of  prices 
which  would  correctly  register  the  improvement  going  on  in 
industry,  and,  moreover,  it  would,  I  believe,  be  so  small  as 
not  to  depart  much  from  the  mutiple  standard.  This  I  infer 
is  also  the  opinion  of  Professor  Marshall. 

Professor  Kinley  makes  the  very  interesting  suggestion  that 
we  can  suppose  a  more  ideal  standard  than  the  tabular  by 
making  our  unit  a  definite  percentage  of  the  national  annual 
dividend.  This  appeals  to  me  as  a  rough  and  ready  way  of 
fixing  a  unit  more  nearly  ideal  than  that  fixed  by  the  tabular 
standard.  But  it  would  certainly  not  be  practicable.  It 
would  not  even  be  quite  ideal.  But  if  Professor  Kinley  will 
measure  his  standard,  the  compensated  dollar  plan  will  be  able 
to  take  care  of  it. 

In  fact,  if  we  could  find  a  more  absolute  standard  than  the 


OBJECTIONS  ANSWERED  237 

tabular  standard  and  could  accurately  measure  it  in  statis- 
tics, precisely  the  same  method  of  compensating  the  dollar 
could  be  employed  to  keep  the  dollar  in  tune  with  that  standard 
as  with  the  tabular  standard.  The  only  difference  would  be 
that  the  guiding  index  would  be  different.  The  plan  for  com- 
pensating the  dollar  does  not  in  essence  consist  in  selecting  the 
multiple  or  any  other  standard.  It  consists  in  a  method  of 
making  the  monetary  unit  conform  to  any  standard  chosen. 
But  there  is  convincing  evidence  that  the  multiple  standard  is 
usually  near  enough  to  the  ideal  for  all  practical  purposes  and 
infinitely  nearer  than  the  gold  standard.  While  individual 
goods  may  vary  greatly  in  absolute  value,  the  general  mass  of 
goods  will  vary  comparatively  little  and  seldom.  There  may 
be  some  absolute  change  in  the  general  mass  of  commodities, 
but  it  must  usually  be  extremely  small  in  comparison  with 
changes  in  any  one  commodity  like  gold.  It  is  clear  from 
the  theory  of  chances  that  this  must  be  the  case.  The  odds 
are  hundreds  to  one  that  the  variations  in  absolute  value  in 
several  hundred  commodities  will  offset  each  other  to  a  large 
degree.  We  very  seldom  have  world  feasts  or  world  famines. 
If  the  corn  crop  is  short  in  some  places  it  is  abundant  in  others. 
If  it  is  short  everywhere  the  crop  of  wheat  or  barley  or  some- 
thing else  is  practically  certain  not  to  be.  We  cannot  expect 
that  everything  will  usually  move  in  one  and  the  same  direc- 
tion. If  there  is  a  war  in  Japan,  it  is  not  likely  that  there 
will  also  be  a  war  in  India.  A  world  war  or  even  anything 
as  near  to  a  world  war  as  the  present  conflict  in  Europe  is  a 
most  unusual  thing. 

A  standard  composed  of  several  hundred  commodities  must 
therefore  be,  in  all  human  probability,  more  stable  than  a 
standard  based,  as  is  our  present  gold  standard,  on  one  com- 
modity. Bimetallists  made  much  of  this  point  when  claiming 
that  two  metals  joined  together  were  steadier  than  one,  just 
as  two  tipsy  men  walk  more  steadily  arm  in  arm  than  sepa- 
rately. Still  more  steady  is  the  average  of  a  hundred  com- 
modities just  as  a  line  of  a  hundred  tipsy  men  abreast  and 
holding  each  other's  arms  will  march  even  more  steadily  than 
two.  This  is  because  it  is  wholly  unlikely  that  every  man  in 
the  line  will  lurch  in  the  same  direction  at  the  same  instant. 


238  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

The  lurching  of  some  in  one  direction  can  always  be  depended 
on  to  offset  almost  entirely  the  lurching  of  others  in  the  other 
direction.  This  theory  of  probabilities  in  its  application  to 
the  present  rise  of  prices  is,  I  believe,  borne  out  by  the  facts. 

After  a  careful  study  of  all  available  evidence,  I  am  con- 
vinced that  the  present  general  rise  in  prices  beginning  in  1896, 
cannot  be  traced  to  any  simultaneous  scarcity  of  goods.  I 
refer  the  reader  to  Why  Is  the  Dollar  Shrinking  f  where  I  have 
given  the  summary  of  the  evidence.  I  think  the  facts  are 
equally  clear  that  the  great  fall  in  prices  from  1873  to  1896 
can  not  be  laid,  wholly  at  least,  to  the  increasing  plenti  fulness 
of  goods. 

Finally,  even  if  we  could  measure  and  apply  an  absolute 
standard,  it  is  doubtful  if,  in  practice,  it  would  be  of  any  more 
service  in  regulating  contracts,  than  a  multiple  standard.  For 
after  all,  as  I  have  tried  to  show  in  Appreciation  and  Interest 
what  we  want  in  a  contract  is  something  that  is  dependable 
rather  than  something  that  is  absolutely  constant ;  and  the  mul- 
tiple standard  gives  dependability  in  terms  of  the  ordinary 
staple  necessities  of  life.  If  we  could  know  that  the  dollar 
always  means  a  definite  collection  of  goods,  we  could  know 
that  the  bondholder  or  the  salaried  man  who  gets  a  stated  in- 
come of  $100  a  month,  would  have  the  same  command  over 
actual  goods,  and  such  knowledge  would  be  of  great  service. 
This  whole  subject  I  have  discussed  in  Chapter  X  of  my  Pur- 
chasing Power  of  Money. 

7.  "  It  would  be  inadequate  to  check  rapid  and  large  changes 
of  the  price  level."  Owing  to  the  narrow  limits,  e.  g.,  i  per 
cent,  as  stated,  imposed  on  the  monthly  adjustments,  it  is  quite 
true  that  a  sudden  and  strong  tendency  of  prices  to  rise  or  fall 
could  not  be  completely  checked.  If  prices  were  to  rise  8  per 
cent,  per  annum  and  the  plan  permitted  no  more  rapid  shift 
than  6  per  cent,  per  annum,  this  would  leave  only  2  per  cent, 
per  annum  uncorrected,  or  only  one-fourth  the  rate  at  which 
prices  would  rise  if  wholly  uncorrected.  But  half  (or  in  this 
illustration  three-quarters  of)  a  loaf  is  better  than  no  bread. 
Moreover,  such  extreme  cases  are  rare  and  when  they  occur 
there  is  all  the  keener  need  for  mitigation  even  if  it  be  some- 
what inadequate.  Ultimately,  of  course,  after  the  rapid  spurt 


OBJECTIONS  ANSWERED  239 

has  abated,  the  counterpoise,  in  its  relentless  pursuit,  would 
overtake  the  escaped  price  level  and  bring  it  back  to  par. 

8.  "  The  correction  always  comes  too  late."     It  is  objected 
that  the  plan  does  not  make  any  correction  until  actual  devia- 
tion has  occurred,  and  so  the  remedy  always  lags  behind  the 
disease.     It  is  true  that  the  corrections  follow  the  deviations. 
They  could  not  precede  them  unless  we  foreknew  what  the 
deviations  were  to  be;  and  we  could  not  afford  to  entrust  the 
work  of  guessing  to  government  officials.     In  this  respect,  as 
in  others,  the  plan  does  not  attain  perfection;  yet  it  is  infinitely 
better  than  the  present  plan,  which  leaves  the  standard  hap- 
hazard.    It  is  also  pointed  out  that  after  the  correction  is 
applied  it  may  happen  that  prices  will  take  the  opposite  turn, 
in  which  case  the  remedy  actually  aggravates  the  disease.     But, 
taking  the  extremely  fitful  course  of  prices  since  1896  and 
correcting  it  according  to  the  plan,  month  by  month,  as  shown 
in  the  Quarterly  Journal  of  Economics  diagram,  we  find  that 
in  nine  cases  out  of  ten  the  opposite  is  true.     Even  in  the  few 
remaining  cases  the  deflections  were  very  slight  and  were,  of 
course,  soon  corrected  immediately  after  the  following  adjust- 
ments.    If  the  corrections  are  sufficiently  frequent,  it  is  im- 
possible not  to  maintain,  in  general,  an  extremely  steady  ad- 
justment. 

When  steering  an  automobile  the  chauffeur  can  only  correct 
the  deviation  from  its  intended  course  after  the  deviation  has 
occurred;  yet,  by  making  these  corrections  sufficiently  fre- 
quent, he  can  keep  his  course  so  steady  that  the  aberrations 
are  scarcely  perceptible.  There  seems  no  reason  why  the 
monetary  automobile  cannot  be  driven  almost  equally 
straight. 

9.  "  The  plan  assumes  that  a  I  per  cent,  fluctuation  can  be 
exactly  corrected  by  a  I  per  cent,  adjustment  of  the  dollar's 
weight."     Owing,  I  fear,  to  my  own  fault  of  phrasing,  I  have 
found  that  several  people  have  acquired  the  mistaken  impres- 
sion that  the  plan  requires,  to  be  made  at  each  adjustment,  an 
increase  of  i  per  cent,  in  the  weight  of  the  dollar  for  every 
i  per  cent,  increase  of  the  index  number  since  the  last  adjust- 
ment; whereas  actually  the  plan  requires,  to  be  made  at  each 
adjustment,  an  increase  of  i  per  cent,  in  the  weight  of  the 


240  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

dollar  for  every  i  per  cent,  excess  of  the  index  above  par  then 
outstanding. 

From  this  mistaken  premise  it  has  naturally  been  inferred 
that,  in  order  that  the  plan  should  work  correctly,  a  I  per  cent, 
loading  of  the  dollar  would  always  have  to  exactly  correct  a 
i  per  cent,  change  in  the  index  number,  and,  very  properly, 
the  critics  doubted  the  truth  of  this.  But  since  the  premise 
was  mistaken  the  objection  based  on  it  disappears. 

10.  "  The  plan  would  be  sure  to  create  dissatisfaction  and 
quarrelling."     This    fear    is,    I    believe,    wholly    imaginary. 
There  would  be  some  ground  for  it  if  the  proposal  were  to 
adopt  the  old  "  tabular  standard  "  by  correcting  money  pay- 
ments through  the  addition  to  or  subtraction  from  the  debt 
of  a  certain  number  of  dollars.     Under  these  circumstances 
the  extra  dollars  paid  or  the  dollars  from  which  the  debtors 
were  excused  would  stand  out  definitely  and  would  be  a  sub- 
ject for  debate  and  dispute,  but  if  the  tabular  standard  were 
merged  in  the  actual  money  of  the  country  the  ordinary  debtor 
and  creditor  would  be  as  unaware  of  how  his  interests  had 
been  affected  as  he  is  now  unaware  of  how  his  interests  are 
affected  by  gold  appreciation.     It  would   still  be  true   that 
to  the  ordinary  man  "  a  dollar  is  a  dollar." 

If  we  cannot  get  the  ordinary  man  to-day  really  excited  over 
the  fact  that  his  monetary  standard  has  affected  him  to  the 
tune  of  some  50  per  cent,  of  his  principal  of  fifteen  years  ago, 
it  does  not  seem  likely  that  he  could  get  excited  because  some 
one  tells  him  that  the  index  number  used  in  the  "'  compensated 
dollar  "  plan  robbed  him  of  i  or  5  per  cent,  as  compared  with 
some  other  possible  system. 

The  debtor  class  favored  in  large  measure  bimetallism, 
or  free  silver,  as  a  means  of  helping  them  pay  debts,  while  the 
creditor  class  opposed  it.  But  this  was  a  question  of  changing 
the  standard,  not  of  keeping  it  unchanged.  If  it  were  pro- 
posed to  shorten  the  yardstick,  undoubtedly  many  who  would 
profit  in  the  outstanding  contracts  would  and  ought  to  oppose 
it.  But  there  is  and  can  be  no  contest  over  efforts  to  keep 
the  yardstick  from  changing. 

11.  "It  has  never  been  tried."     True;  but  the  proposal  is, 
in  mechanism,  almost  identical  with  the  gold  exchange  device 


OBJECTIONS  ANSWERED  241 

introduced  by  Great  Britain  to  maintain  the  Indian  currency 
at  par  with  gold.  The  system  here  proposed  would  really  be 
to-day  less  of  an  innovation  in  principle  than  was  the  Indian 
system  when  introduced  and  developed  between  1893  and 
1900,  while  the  evils  it  would  correct  are  similar  to,  but  vastly 
greater  than,  the  evils  for  which  the  Indian  system  was  de- 
vised. 

The  truth  is,  unless  I  am  greatly  mistaken,  that  the  last 
named  is  the  only  strong  objection  to  the  plan  in  the  minds 
of  most  of  its  critics ;  it  is  the  constitutional  objection  to  any 
change  of  the  status  quo.  It  is  simply  the  temperamental  op- 
position to  anything  new.  As  Bunty  well  says  in  the  play, 
"  anything  new  is  scandalous."  The  conservative  tempera- 
ment dislikes  experiment  because  it  is  experiment.  Accord- 
ingly it  is  not  surprising  that  we  find  many  of  the  objectors 
saying,  "  let  well  enough  alone,"  "  let  us  '  rather  bear  those 
ills  we  have  than  fly  to  others  that  we  know  not  of.' '  These 
people  seldom  give  assent  to  untried  experiments;  yet  after 
the  new  plan  has  been  tried  and  established  they  invariably 
turn  about  and  become  its  most  staunch  supporters.  This  fact 
has  been  often  illustrated  in  our  monetary  and  banking  sys- 
tem. Nothing  short  of  the  shock  of  civil  war  was  required 
to  divert  us  from  a  state  system  of  banking  to  a  national  one. 
In  spite  of  the  intolerable  evils  of  the  former,  it  was  easy  to 
find  many  arguments  in  its  favor.  After  the  change  these 
arguments  never  reappeared.  The  same  was  true  of  slavery. 

But  conservatism  always  yields  gradually  to  pressure.  Its 
resistance  is  strong  but  has  no  resiliency.  It  is  not  like  the 
resistance  of  a  steel  spring  (which,  when  pushed  in  one  direc- 
tion, will  bend  back),  but  a  mass  of  dough  or  putty  which, 
though  it  resists  impact  strongly,  yet  when  it  is  moved  stays 
inert  and  does  not  return.  Under  these  circumstances,  even 
if  progress  is  made  an  inch  at  a  time,  it  seems  to  me  worth 
while  to  try  to  make  it.  The  two  steps  first  necessary  have 
been  taken,  namely,  the  perfecting  of  the  plan  and  the  running 
the  gauntlet  of  criticism. 

It  is  not  impossible,  judging  from  the  many  and  authorita- 
tive endorsements  of  the  plan,  that  it  may  be  pushed  rapidly 
toward  realization.  All  depends  on  the  opening  up  of  oppor- 


242  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

tunities.  After  the  present  war,  for  instance,  it  may  be  that 
"  internationalism  "  will  come  into  a  new  vogue  and  that  some 
special  opportunity  will  be  afforded  to  bring  the  plan  with  its 
endorsements  to  the  serious  attention  of  the  world's  adminis- 
trative officials. 

1  It  must  be  admitted  at  the  outset  that  the  plan,  if  carried 
out  with  iron  consistency  for  a  considerable  stretch  of  time, 
would  achieve  the  result  mainly  had  in  view  —  the  prevention 
of  a  long-continued  and  considerable  rise  in  prices.  It  might 
not  achieve  that  result  as  smoothly  and  evenly  as  its  proposer 
expects ;  and  the  qualifications  just  stated  —  that  it  must  be 
carried  out  unflinchingly  for  a  long  period  —  should  be  borne 
in  mind.  No  one  who  holds  to  the  doctrine  that  the  general 
range  of  prices  is  determined  by  the  relation  between  the  quan- 
tity of  commodities  and  the  volume  of  the  circulating  medium, 
and  that  the  volume  of  the  circulating  medium  in  the  end  de- 
pends, cetcris  paribus,  on  the  amount  of  coined  money,  can 
do  otherwise  than  admit  the  logical  soundness  of  the  scheme. 
He  who  maintains  that  the  -/ise  in  prices  during  the  last  fifteen 
years  is  due  to  the  greater  gold  supply  must  admit  that  a  re- 
striction of  the  monetary  supply  of  gold  will  check  the  rise. 
The  plan  proposed  is  in  essence  one  for  a  regulation  in  the 
monetary  supply  of  gold.  Its  effects  must  be  the  same  in  kind 
as  those  of  a  cessation  of  free  coinage,  with  an  apportioned 
limited  coinage.  .  .  . 

The  question  arises  whether  it  would  be  feasible  for  one 
country  alone  to  adopt  the  plan.  It  would  be  feasible,  in  the 
same  sense  that  it  would  be  feasible  for  all  countries  together 
to  adopt  it.  One  country  alone,  carrying  it  out  with  unflinch- 
ing consistency,  might  secure  the  desired  result,  subject  to  the 
qualifications  which  have  already  been  indicated.  But  that 
any  one  country  would  in  fact  adopt  it  alone  seems  to  me  in 
the  highest  degree  improbable. 

Consider  for  a  moment  the  mode  in  which  the  scheme  would 
work  in  detail  if  adopted  by  a  single  country.  Though  the 
immediate  effect  upon  general  prices  within  the  country  would 

1  F.  W.  Taussig,  The  Plan  for  a  Compensated  Dollar,  The  Quarterly 
Journal  of  Economics,  Vol.  27,  May,  1913,  pp.  401-416. 


EFFECTS  OF  A  SEIGNIORAGE  243 

be  unpredictable,  the  effect  upon  certain  kinds  of  prices  would 
be  certain,  predictable,  almost  instantaneous.  Exported  com- 
modities would  feel  the  effect  at  once.  Their  prices  are  deter- 
mined, to  use  the  current  expression,  by  the  foreign  market. 
It  would  be  more  accurate  to  say  that  their  prices  are  deter- 
mined by  the  total  market,  domestic  as  well  as  foreign.  But ' 
it  is  clear  that  their  prices  must  be  the  same  (due  allowance 
being  made  for  transportation  charges  and  the  like)  within 
the  country  as  without.  Now  the  immediate  effect  of  a  seign- 
iorage would  be,  as  Professor  Fisher  points  out,  a  readjust- 
ment of  the  par  of  foreign  exchange.  The  exporter  would 
find  the  par  of  exchange  lessened,  and  in  terms  of  domestic 
money  (compensated  dollars)  he  would  receive  less  than  he 
got  before.  All  commodities  of  export  would  fall  in  price 
at  once,  or  fail  to  rise,  to  the  extent  of  the  seigniorage.  Other 
commodities  probably  would  be  unaffected  for  the  moment. 
In  the  long  run,  no  doubt,  these  other  commodities  (we  may 
call  them  domestic  commodities)  would  also  be  affected.  But, 
to  repeat,  the  rapidity  and  extent  of  the  change  in  general 
prices  is  impossible  of  prediction.  The  exporters,  none  the 
less,  would  feel  an  immediate  and  unmistakable  effect.  Be- 
yond question  they  would  be  as  hotly  indignant  with  the  plan 
as  if  an  excise  tax  had  been  imposed  on  their  commodities 
without  any  possibility  of  their  raising  the  price  of  their  prod- 
ucts. Consider  for  a  moment  what  would  be  the  state  of 
mind  in  our  cotton-exporting  South.  Is  it  to  be  supposed  that 
any  set  of  legislators  could  resist  the  political  pressure  from 
the  various  exporting  sections,  and  carry  out  the  scheme  un- 
flinchingly? Can  we  imagine  a  Congressman  telling  his  con- 
stituents that  they  need  only  wait  a  while,  until  all  money  in- 
comes and  all  prices  had  adjusted  themselves  to  the  new  con- 
ditions? that  then  nobody  would  be  worse  off  or  better  off 
than  before?  To  ask  this  sort  of  question  is  to  answer  it. 
The  very  proposal  of  the  scheme  in  the  halls  of  Congress 
would  invite  the  hot  opposition  of  the  exporting  sections  and 
industries.  Its  immediate  consequences  for  them  would  be 
seen  quickly  enough,  and  no  promise  of  ultimate  adjustment 
would  lessen  their  hostility.  .  .  . 

Professor  Fisher  has  predicted  that  prices  will  rise  further. 


244  A  PLAN  FOR  A  COMPENSATED  DOLLAR 

He  is  disposed  to  believe  that  there  will  be  not  only  a  rise,  but 
that  there  will  be  a  considerable  rise.  I  hesitate  very  greatly 
to  enter  the  domain  of  prediction.  I  am  inclined  to  believe 
that  the  rise  in  prices  will  not  cease  for  the  next  decade;  but 
whether  it  will  be  considerable  or  moderate  or  negligible  in 
extent,  I  should  not  venture  to  say.  Predictions  concerning 
the  output  from  the  mines  are  to  be  taken  with  the  greatest 
caution.  We  all  recall  the  predictions  which  Suess  made  in 
1892.  The  distinguished  geologist  believed  that  the  prospects 
of  an  increased  production  of  gold  were  of  the  slightest,  and 
that  the  world  must  fall  back  on  the  use  of  both  metals.  How 
different  the  course  of  events  has  been  from  that  which  he 
predicted!  There  are  those  who  believe  that  the  output  of 
gold,  so  far  from  continuing  to  increase,  has  reached,  or  is 
approaching,  its  maximum.  For  myself,  I  should  not  be  sur- 
prised if  there  were  a  cessation  in  growth,  and  should  cer- 
tainly be  surprised  if  there  were  not  a  relaxation  in  the  rate 
of  growth. 

Further:  it  deserves  to  be  borne  in  mind  that  the  total  sup- 
ply of  the  precious  metals  is  now  so  much  greater  than  it  was 
twenty  years  ago  that  the  same  annual  increment  will  have 
much  less  effect  on  prices.  This  is  the  familiar  consequence 
of  the  durability  of  the  precious  metals.  .  .  . 

Finally,  a  circumstance  should  be  borne  in  mind  which  bears 
not  only  upon  the  intrinsic  desirability  of  a  regulative  plan, 
but  also  upon  the  attitude  of  the  general  public  and  the  con- 
sequent political  and  industrial  possibilities.  Economists  are 
familiar  with  the  difference  between  the  phrase  which  they 
use  in  describing  the  new  conditions,  and  that  which  is  current 
in  popular  discussion.  The  economists  speak  of  the  "  rise  in 
prices  " ;  the  general  public  speaks  of  the  "  high  cost  of  liv- 
ing." The  difference  in  phraseology  is  not  due  simply  to  vari- 
ation of  the  point  of  view.  It  results  from  the  fact  that  very 
different  phenomena  are  had  in  mind  by  the  two  sets  of  per- 
sons. The  economist  is  thinking  and  reasoning  about  the 
change  which  has  been  of  special  interest  for  him  —  the  gen- 
eral rise  in  prices.  The  man  on  the  street  is  thinking  about 
the  exceptional  rise  in  the  prices  of  one  important  set  of  com- 
modities. Any  one  who  will  examine  with  care  the  index 


HIGH  COST  OF  LIVING  245 

numbers  of  our  Bureau  of  Labor  will  see  what  a  marked  rise, 
much  beyond  that  of  the  general  index  number,  has  appeared 
in  the  prices  of  farm  products,  and  especially  in  the  prices  of 
meat.  That  special  advance  has  taken  place  within  the  last 
three  or  four  years.  It  is  precisely  within  this  period  that 
general  attention  has  been  turned  to  rising  prices.  What  the 
public  has  had  chiefly  in  mind  has  been  the  commodities  of 
wide  consumption.  This,  I  believe,  is  the  main  cause  of  labor 
unrest.  .  .  . 

Whatever  be  the  particular  causes  that  have  led  to  the  high 
prices  of  food,  economists  agree  that  these  causes  will  operate 
irrespective  of  any  compensated  dollar  plan.  This  would  sim- 
ply serve,  at  its  best,  to  keep  general  prices  where  they  are, 
leaving  each  particular  group  of  commodities  subject  to  its 
own  particular  set  of  causes.  If  the  compensated  dollar  plan 
were  to  be  adopted,  and  if  the  prices  of  food  should  continue 
to  mount,  there  would  be  disappointment  for  the  general  pub- 
lic, but  nothing  to  surprise  the  economist.  And  conversely, 
it  is  entirely  possible  that  the  rise  in  the  cost  of  living,  that  is, 
the  special  rise  in  the  prices  of  foodstuffs,  will  reach  its  end 
irrespective  of  any  monetary  change  whatever.  The  general 
rise  in  prices  and  money  incomes  ...  is  not  unwelcome  to  the 
great  majority  of  people.  Its  incidental  consequences  are  per- 
ceived and  debated  chiefly  by  the  economists ;  such  as  the  ef- 
fects on  the  creditor  class  and  the  slowness  of  so-called  fixed 
incomes  to  rise  correspondingly.  The  general  public  is  con- 
cerned chiefly  with  the  conspicuous  rise  in  the  prices  of  food- 
stuffs, which  is  ascribable  to  causes  very  different  from  those 
that  bring  the  general  rise,  and  can  be  reached  only  by  reme- 
dies very  different.  .  .  . 


CHAPTER  XIV 
MONETARY  SYSTEMS  OF  FOREIGN  COUNTRIES 

ENGLAND  * 

2  THE  monetary  unit  is  the  pound,  or  sovereign,  equal  to 
$4.8665,  divided  into  20  shillings  of  12  pence  each,  each  penny 
equal  to  4  farthings.  Originally  the  pound  was  a  Troy  pound 
of  silver,  .925  fine.  Under  the  law  of  1816  gold  was  made 
the  standard  and  silver  subsidiary.  The  coinage  of  gold  is 
free,  and  to  avoid  delay  the  Bank  of  England  is  required  to 
buy  all  gold  and  pay  for  the  same  at  once  at  the  [minimum] 
rate  of  £3  ijs.  gd.  per  ounce,  a  [maximum]  charge  of  il/>d. 
being  imposed  for  the  accommodation.  Silver  is  only  coined 
on  government  account  and  the  coinage  ratio  is  14.29  to  one. 

They  have  the  gold  sovereign  (containing  113.001  grains 
pure  gold),  the  unit  of  their  currency,  also  half-sovereigns, 
crowns  ($s.),  double  florins,  (4^.),  half-crowns,  florins,  shil- 

1  The  following  table,  from  The  Monetary  Systems  of  the  Principal 
Countries  of  the  World,  compiled  in  the  office  of  the  Director  of  the  Mint, 
Washington,  1912,  gives  the  weight,  fineness,  etc.,  of  the  coins  of  Great 
Britain: 

GOLD 


Pure 

Value  in 

Denominations. 

Weight. 

Fineness. 

Fine 

Weight. 

gold  or 

United 

* 

weight. 

silver. 

States  money. 

Grams. 

Thou- 

sandths. 

Grams. 

Grains. 

Grains. 

39  9410 

gi62/3 

36  6125 

565  0080 

$24.3325 

i  ^.0764 

9i62/3 

246.5488 

226  0032 

9.7330 

Sovereign     

7.9881 

9i62/3 

7.3225 

123.2744 

1  1  3.0016 

4.8665 

Half  sovereign   .... 

3-9941 

9it>2/3 

3.6612 

61.6372 

56.5008 

2.4332 

SILVER 


$0  6083 

Florin   

925 

4866 

Shilling  

2433 

1216 

Fourpence  (groat)  . 

1.8850 

925 

«.7436 

29.0893 

21  8l62 

26.9071 
20  1788 

08  1  1 
0608 

8718 

0405 

Penny  

41C8 

6.7252 

O2O2 

2  A.  Barton  Hepburn,  A  History  of  Currency  in  the  United  States,  pp. 
450-473.    The  Macmillan  Company.     New  York.     1915. 

246 


CANADA  247 

lings,  six  and  three  pence  pieces,  four  pence  (groat),  two  pence 
and  penny,  all  in  silver,  also  penny,  half-penny,  and  farthing 
in  bronze.  A  few  English  banks,  operating  under  old  char- 
ters, issue  notes  to  a  limited  extent,  which  circulate  as  money. 
Otherwise  the  paper  currency  of  England  and  Wales  consists 
wholly  of  notes  of  the  Bank  of  England.  .  .  . 

Extraordinary  measures  were  resorted  to  by  the  British 
government  in  the  early  stages  of  the  European  war  of  1914; 
with  the  close  of  the  war  currency  conditions  will  doubtless 
go  back  to  normal,  as  described  above. 

The  Government,  also,  under  date  of  August  6,  authorized 
an  issue  of  currency  notes,  in  denominations  of  £i  and  10  shil- 
lings. .  .  . 

These  notes,  which  were  first  issued  to  the  public  August  7, 
were  deposited  with  the  Bank  of  England  for  account  of  the 
British  government,  as  the  practical  way  of  getting  them  into 
use;  they  were  used  for  various  purposes,  including  advances 
to  banks  at  5  per  cent,  per  annum,  up  to  20  per  cent,  of  their 
deposits;  the  volume  outstanding  December  30,  1914,  was 
£38,478,164;  the  amount  outstanding  on  June  23,  1915,  was 
£46,199,705.  These  notes  were  protected  in  part  by  securi- 
ties and  by  an  increasingly  large  gold  reserve,  exceeding  75 
per  cent,  in  March,  1915. 

Postal  orders  were  made  legal  tender  and  so  remained  until 
February  4,  1915.  .  .  . 

CANADA 

In  1857  the  legislature  of  Upper  and  Lower  Canada  for- 
mally adopted  dollars  and  cents  as  the  money  in  which  public 
accounts  should  be  kept.  The  Confederation  in  1867  adopted 
the  same  for  the  Dominion,  retaining,  however,  the  sovereign. 

In  1871  the  Currency  Act  prescribed  the  same  for  all  ac- 
counts, providing  also  that  the  gold  coins  of  the  United  States 
of  America  should  be  legal  tender  along  with  British  sover- 
eigns, the  latter  at  a  rating  of  $4.86  2/3. 

The  silver  and  bronze  tokens  (including  pieces  of  50,  25, 
20,  10,  5,  and  I  cents)  had  been  supplied  from  the  London 
Mint,  or  from  Birmingham  on  its  behalf,  from  1856  to  1907. 
After  the  Confederation  no  more  coins  were  issued  for  the 


248       MONETARY  "SYSTEMS  OF  FOREIGN  COUNTRIES 

separate  Provinces.  The  twenty-cent  piece  (though  still  re- 
tained by  Newfoundland)  has  not  been  struck  for  Canada 
since  1864. 

From  January  2,  1908,  the  whole  supply  of  British  and 
Canadian  coins  was  undertaken  by  the  Ottawa  Mint.  V*  By  the 
Ottawa  Mint  Act  the  Dominion  Parliament  undertook"  the  sup- 
port of  a  branch  of  the  Royal  Mint  in  Ottawa,  the  adminis- 
tration to  be  in  the  hands  of  the  British  Treasury.  This  sys- 
tem (the  same  as  that  of  the  Australian  Branch  Mints,  Syd- 
ney, Melbourne,  Perth)  was  preferred  to  the  plan  of  an  inde- 
pendent Dominion  Mint  because  that  was  the  only  way  of  pro- 
curing the  privilege  of  coining  British  sovereigns. 

A  royal  proclamation  published  on  November  2,  1907,  duly 
established  a  branch  of  the  Royal  Mint  at  Ottawa,  and  author- 
ized the  coinage  of  British  sterling  gold  coins  irom  dies  pre- 
pared in  England,  such  coins  to  rank  with  those  struck  in  Lon- 
don. The  depositor  of  gold  bullion  has  the  right  to  demand 
British  sovereigns  in  exchange.  .  .  . 

The  British  sovereign  (or  pound)  is  legal  tender  in  Canada 
at  $4.8666.  The  American  gold  coins  are  also  legal  tender. 
Canadian  silver  coins  are  925  parts  fine,  and  have  a  slightly 
less  amount  of  fine  silver  than  United  States  of  America  sil- 
ver coins  of  similar  circulating  values.  The  dollar,  though 
sanctioned,  has  not  yet  been  struck. 

Paper  currency  consists  of  legal-tender  Dominion  notes  and 
bank-notes  issued  against  the  credit  of  the  banks;  there  were 
at  the  end  of  1914  22  banks,  with  3,130  branches  in  the  Domin- 
ion, 20  in  Newfoundland  and  72  in  the  United  States  and 
other  foreign  countries.  .  .  . 

On  July  31,  1914,  just  before  the  war,  Dominion  notes  were 
issuable  without  limit,  providing  the  amount  over  $30,000,000 
was  covered  by  gold.  The  volume  at  that  time  was  $112,- 
821,618.53  and  the  gold  held  amounted  to  $90,292,833.28. 
As  a  consequence  of  the  war  the  limit  beyond  which  Dominion 
notes  may  not  ordinarily  be  issued  without  being  entirely  cov- 
ered by  gold  was  by  an  Act  passed  in  August  increased  from 
$30,000,000  to  $50,000,000.  .  .  . 


BRITISH  COLONIES  249 

BRITISH  COLONIES 

The  British  West  Indies,  as  also  Guiana,  make  British  gold 
legal  tender.  United  States  gold  also  circulates  freely. 
There  are  a  few  banks  with  limited  note-issuing  power,  and 
minor  coins  are  similar  to  those  of  England.  There  is  a  grow- 
ing use  of  United  States  currency. 

British  Honduras  has  a  dollar  unit,  identical  with  that  of 
the  United  States. 

British  India  has  .  .  .  adopted  the  gold  [-exchange]  stand- 
ard and  India  has  for  some  years  been  largely  absorbing  gold ; 
the  pound  is  the  unit —  the  metallic  currency,  mainly  silver, 
is  maintained  at  parity  with  gold  by  an  arbitrary  valuation  or 
rate  of  exchange.  The  principal  coin  is  the  rupee,  equal  to 
$0.3244;  by  a  fixed  government  rating  15  rupees  equal  £i. 
There  is  a  gold  [-exchange]  standard  reserve  for  India, 
amounting,  March  13,  1915,  to  £25,627,393,  about  one-half 
held  in  India  and  one-half  in  London;  it  consists  of  gold  and 
investments.  .  .  .  Paper  money  is  issued  only  by  the  Govern- 
ment and  is  covered  by  gold,  silver  largely,  and  securities  to 
some  extent. 

The  Straits  Settlements  have  a  dollar  currency,  divided  into 
100  cents;  the  value  of  the  dollar  was  fixed  by  the  Government 
at  2.S.  4d.}  on  January  29,  1909,  and  has  since  been  maintained 
at  approximately  that  rate,  a  gold  [-exchange]  standard  re- 
serve being  accumulated  for  that  purpose.  The  system  is 
copied  after  that  of  India. 

Hong  Kong,  silver  standard,  is  the  exchange  point  between 
gold  and  silver  countries,  and  hence  important.  The  British 
dollar  of  416  grains  is  the  principal  coin.  It  fluctuates  in 
value  with  the  value  of  silver  bullion. 

Australia  and  New  Zealand  have  the  British  system  of  bank- 
ing. There  are  many  banks,  some  with  British  charters,  and 
many  branches;  they  issue  notes  covered  by  gold.  Gold  in 
large  quantities  has  been  produced  in  these  states  since  1851. 

British  Africa  and  other  minor  Eastern  possessions  have  the 
British  system,  modified  in  various  respects. 

Egypt  having  recently  been  formally  annexed  by  Great 
Britain,  her  monetary  system  will  naturally  be  closely  identi- 


250      MONETARY  SYSTEMS  OF  FOREIGN  COUNTRIES 

fied  with  that  of  England  in  the  future.     The  English  sover- 
eign has  been  for  many  years  the  gold  coin  of  common  use. 

LATIN  UNION 

The  Latin  Union  consists  of  France,  Italy,  Belgium,  Swit- 
zerland and  Greece;  they  are  bimetallic,  both  gold  and  silver 
being  full  legal  tender,  and  the  coinage  ratio  being  15^2  to  I ; 
they  have  identical  systems,  and  formed  a  union  to  maintain 
the  parity  of  silver  and  gold,  at  the  above  ratio,  by  accepting 
each  other's  silver  coins;  while  their  systems  are  bimetallic  in 
law,  silver  is  now  coined  only  in  small  denominations  and  on 
government  account.  The  general  adoption  of  the  gold  stand- 
ard by  other  countries  has  embarrassed  the  efforts  of  the  Union 
to  preserve  the  parity  and  also  the  inte*rchangeability  of  silver 
coins  between  these  nations. 

FRANCE 

France  has  the  franc,  equal  to  $0.193,  as  tne  monetary  unit; 
the  principal  gold  coin  is  the  loiiis,  equal  to  20  francs.  The 
paper  currency  of  France  is  issued  wholly  by  the  Bank  of 
France,  a  private  corporation,  privately  owned,  but  whose  chief 
officers  are  appointed  by  the  Government,  which  thereby  ob- 
tains a  general  control  of  policy  and  administration ;  the  maxi- 
mum amount  of  note-issue  is  fixed  by  law,  arbitrarily,  and  by 
occasional  increase  is  kept  well  ahead  of  the  country's  necessi- 
ties; no  fixed  legal  reserve  is  required,  but  the  total  note-issue 
must  be  covered  by  gold,  silver,  securities,  and  commercial 
paper;  as  a  matter  of  fact  it  carries  very  large  metallic  re- 
serves, and  since  it  may  lawfully  pay  its  obligations  in  either 
gold  or  silver,  it  can  always  conserve  its  gold  holdings  by  re- 
quiring a  premium  for  the  same,  or  withhold  gold  payment 
altogether. 

It  has  over  400  branches  and  the  same  rate  of  discount  ob- 
tains in  all  branches  on  the  same  day;  it  thus  regulates  and 
controls  the  interest  rate  throughout  France,  in  the  interest  of 
uniformity  and  fairness;  it  may  do  business  with  banks  or 
individuals  and  has  many  very  small  loans;  its  notes  are  a 
legal  tender;  the  power  to  issue  currency  is  one  of  its  chief 
elements  of  banking  power.  .  .  . 


LATIN  UNION  251 

BELGIUM 

Belgium  is  bimetallic  and  its  coins  are  the  same  as  those  of 
France  and  have  unlimited  lawful  currency;  bank-notes  are 
issued  only  by  one  bank,  privately  owned ;  the  Government  re- 
ceives a  share  of  the  dividends  in  excess  of  6  per  cent,  and 
imposes  a  tax  upon  the  note-issues ;  demand  liabilities,  includ- 
ing notes,  must  be  protected  by  a  coin  reserve  of  33  1/3  per 
cent,  and  the  notes  must  be  covered  by  cash,  commercial  paper 
and  securities. 

ITALY 

Italy  has  the  lira,  equal  to  $0.193,  and  divided  into  100 
centesimi;  her  coins  correspond  to  those  of  France;  the  Bank 
of  Italy  largely,  and  two  other  banks  to  a  lesser  extent,  issue 
notes  against  their  credit,  limited,  however,  to  three  times 
their  capital,  unless  covered  by  gold;  the  issue  may  be  in- 
creased, but  comes  in  for  a  tax  of  i  per  cent,  per  annum  and 
must  be  protected  by  a  33  1/3  per  cent,  reserve  in  coin  and 
foreign  exchange.  .  .  . 

SWITZERLAND 

Switzerland's  coinage  system  duplicates  that  of  France,  and 
her  Federal  Bank  is  very  similar  to  the  Bank  of  France.  .  .  . 

GREECE 

Greece  .  .  .  has  for  its  monetary  unit  the  drachma,  equal 
to  $0.193.  Her  coinage  follows  the  Latin  Union  agreement. 
Paper  currency  is  issued  both  by  the  Government  and  by  banks, 
and  both  are  depreciated.  Greece  had  to  resort  to  emergency 
measures  during  the  Balkan  War,  which  may  have  an  influ- 
ence upon  her  currency  for  some  time. 

SPAIN 

Spain  .  .  .  has  the  peseta,  equal  to  $0.193  United  States, 
as  her  unit.  The  Bank  of  Spain  has  the  sole  right  to  issue 
notes,  which  may  equal  five  times  its  capital  and  must  be  pro- 
tected by  a  25  per  cent,  coin  reserve.  Gold  commands  a 
premium.  Silver  is  coined  only  on  Government  account.  .  .  . 


252      MONETARY  SYSTEMS  OF  FOREIGN  COUNTRIES 

GERMANY 

Germany,  gold  standard,  has  for  her  currency  unit  the  mark, 
of  100  pfennig,  equal  to  $0.238;  the  5-mark  piece  contains  the 
same  amount  of  pure  silver  as  the  5-franc  piece  and  two  United 
States  half-dollars.  .  .  .  Silver  is  legal  tender  to  the  amount 
of  20  marks.  The  coins  for  her  colonies  are  varied  to  suit 
local  needs. 

AUSTRIA-HUNGARY 

Austria-Hungary,  gold  standard,  has  as  its  unit  the  krone, 
equal  to  $0.2026;  2O-krone  and  lo-krone  pieces  are  coined  in 
gold,  also  gold  ducats,  worth  $2.288;  silver  coins  are  of  va- 
rious fineness.  .  .  . 

PORTUGAL 

The  Portuguese  Government,  by  decree  of  May  22,  1911, 
adopted  a  new  monetary  system  and  the  coins  will  be  placed 
in  circulation  as  soon  as  possible.  The  unit  of  the  system, 
excepting  for  her  possessions  in  India,  is  the  gold  escudo,  .  .  . 
equal  to  $1.08  American  gold.  The  escudo  is  divided  into  100 
equal  parts  called  centavos.  .  .  .  Multiples  are  2,  5,  and  10 
escudos.  Divisions  of  the  escudo  are  of  silver,  with  values 
of  50,  20,  and  10  centavos;  subsidiary  coins  consist  of  bronze 
and  nickel  pieces.  Her  currency  is  not  maintained  at  a  parity 
with  gold. 

NETHERLANDS 

.  .  .  The  unit  is  the  florin  or  guilder  of  100  cents,  equal  to 
$0.402.  The  lo-florin  piece  is  the  principal  gold  coin;  the 
ryksdaalder  (2^  florins),  the  florin  and  half-florin  in  silver 
are  legal  tender,  as  well  as  all  gold  coins ;  silver  is  maintained 
at  parity  with  gold  by  law;  coinage  of  silver  is  only  on  Gov- 
ernment account ;  paper  money  is  issued  by  a  central  bank  and 
40  per  cent,  metallic  (gold  and  silver)  reserve  is  required 
against  deposits  as  well  as  notes ;  the  balance  of  the  notes  are 
covered  by  negotiable  instruments.  The  central  bank  was 
organized  in  1814.  Banking  in  the  Netherlands  is  excellently 
managed. 


SCANDINAVIAN  UNION  253 

SWEDEN  —  NORWAY  —  DENMARK  (SCANDINAVIAN  UNION) 

These  have  the  gold  standard  and  have  for  their  unit  the 
krone,  equal  to  $0.268  United  States  currency ;  their  subsidiary 
silver  has  various  fineness ;  paper  currency  of  Sweden  is  issued 
by  the  Royal  Bank,  owned  by  the  Government ;  notes  are  legal 
tender  and  may  be  issued  to  a  fixed  amount  in  excess  of  gold 
on  hand  or  in  foreign  banks,  but  must  at  all  times  have  gold 
to  the  extent  of  at  least  10,000,000  kroner. 

Norway  has  a  single  bank  of  issue,  controlled  by  the  State, 
which  owns  a  majority  of  the  stock;  notes  are  legal  tender 
and  may  be  issued  to  twice  the  amount  of  gold  on  hand  and 
in  foreign  banks. 

Denmark's  paper  money  is  issued  by  a  privately  owned  bank, 
but  under  strict  control  by  the  Government ;  the  notes  are  legal 
tender  and  may  be  issued  to  a  sum  30,000,000  kroner  in  excess 
of  the  gold  on  hand. 

RUSSIA 

Russia  is  on  a  gold  basis  and  has  for  its  unit  the  ruble,  of 
TOO  kopecks,  equal  to  $0.51456  in  United  States  currency;  the 
silver  coins  in  common  use  are  the  ruble,  one-half  and  one- 
fourth  ruble;  paper  money  is  issued  by  the  Imperial  Bank, 
which  is  owned  by  the  Government  and  managed  as  part  of 
its  finance  department;  the  law  requires  the  coin  reserve  to 
equal  two-thirds  of  the  note  issue.  .  .  . 

JAPAN 

Japan  maintains  the  gold  standard  and  its  unit  is  the  yen, 
equal  to  $0.498;  the  yen  is  divided  into  100  sen,  the  sen  into 
10  rin.  The  yen  equals  1 1.574  grains  of  pure  gold. 

The  Bank  of  Japan  may  issue  notes  to  the  extent  of  $120,- 
000,000  upon  securities,  any  amount  upon  specie,  and  also  may 
issue  further  sums  in  excess  of  specie,  subject  to  a  tax  of  5 
per  cent.  The  stock  of  the  bank  is  all  privately  owned.  Japan 
first  copied  the  national  banking  system  of  the  United  States 
and  after  trial  abandoned  the  same  for  a  central  bank.  She 
has  managed  her  finances  and  her  banking  with  wonderful 
ability  and  great  success.  Besides  the  Bank  of  Japan,  there 


254      MONETARY  SYSTEMS  OF  FOREIGN  COUNTRIES 

are  many  strong  private  banks,  notably  the  Yokohama  Specie 
Bank. 

CHINA 

China,  silver  basis,  had  for  its  unit  the  tael,  divided  into 
1000  cash;  there  are  said  to  be  sixteen  different  kinds  of  tael 
in  the  different  states  of  China;  the  most  valuable  is  the 
"  Haikwan,"  or  "  customs  tad,"  the  one  in  which  customs  dues 
are  reckoned,  and  this  equalled  $0.664  in  United  States  cur- 
rency, October  i,  1914.  The  cash  is  of  base  metal,  with  a 
square  hole  punched  in  the  centre  and  is  worth  less  than  a  mill 
in  our  currency. 

In  the  last  years  of  the  Empire  a  new  system  of  coinage 
was  established  and  since  continued  by  the  Republic.  The  unit 
is  the  yuan  of  silver,  worth  $0.477,  but  varies  with  the  price 
of  silver;  one-half,  one-fifth,  and  one-tenth  yuan  are  also 
coined  in  silver  and  smaller  coins  in  copper  and  brass.  .  .  . 

PHILIPPINES 

The  unit  of  value  is  the  peso,  equal  to  $0.50  in  United  States 
currency.  The  fiscal  affairs  are  administered  by  the  United 
States  and  the  currency  is  safe  and  maintained  on  [essen- 
tially] a  gold  basis. 

ARGENTINA 

At  a  time  when  the  cultivation  and  development  of  trade 
relations  with  South  America  seem  most  alluring,  we  find  a 
principal  embarrassment  in  the  currency  and  credit  conditions 
which  obtain  in  most  South  American  States,  but  Argentina, 
one  of  the  most  favored  of  South  American  States,  has  a 
stable  and  sound  currency  system.  Her  unit  is  the  peso,  of 
loo  centavos.  The  gold  peso  is  equal  to  $0.9647  in  United 
States  money.  In  1889  the  Government  took  measures  to 
acquire  gold  and  fixed  the  relation  of  paper  to  gold  at  227.27 
per  cent.,  and  it  has  since  been  maintained  at  that  level  without 
fluctuation.  This  made  the  paper  peso  equal  to  about  $0.44 
gold.  They  have  a  very  large  gold  reserve  in  their  caja  dc 
conversion,  262,000,000  pesos  gold,  which  protects  the  paper 
money  and  gives  it  stability.  Gold  payments  were  suspended 


BRAZIL  AND  CHILI  255 

temporarily    at    the    commencement    of    the    European    war 
(1914),  but  paper  money  seems  to  have  remained  at  par.  .  .  . 

BRAZIL 

Brazil  was  formerly  a  colony  of  Portugal,  and  naturally 
copies  the  parent  country  in  her  currency  system.  Her  unit  is 
the  milreis,  of  1000  reis.  Nominally  the  gold  standard  pre- 
vails, but  depreciated  paper  is  the  currency  of  her  commerce. 
The  milreis  contains  12.686  grains  of  pure  gold  and  is  worth 
in  United  States  currency  $0.546. 

In  1898  the  Government  assumed  the  sole  power  to  issue 
paper  money,  and  strove  to  bring  the  same  to  a  parity  with 
gold;  the  arbitrary  valuation  put  upon  the  milreis  by  the  Gov- 
ernment was  15^.  or  $0.30. 

.On  December  20,  1910,  the  value  of  a  milreis  was  raised  to 
i6d.  The  Government  accumulated  a  conversion  fund,  under- 
stood to  be  $60,000,000  to  $70,000,000,  but  owing  to  crises  at 
home  and  abroad  it  has  not  yet  been  able  to  make  gold  and 
paper  notes  interconvertible. 

Brazil  possesses  an  enormous  area,  and  is  wonderfully  rich 
in  undeveloped  resources.  Her  coffee  and  rubber  are  espe- 
cially valuable  and  should  take  care  of  her  international  trade 
balances.  In  the  near  future  her  currency  should  become 
stable  and  free  from  fluctuation.  Brazilians  receive  important 
service  from  foreign  banks  and  bankers. 

CHILI 

Chili  has  the  gold  standard,  but  her  paper  currency  is  not 
maintained  at  a  parity  with  gold;  her  unit  is  the  peso,  of  100 
centavos,  of  the  value  of  iSd.  .  .  . 


CHAPTER  XV 

THE  NATURE  AND  FUNCTIONS  OF  TRUST 
COMPANIES 

1  THE  trust  company  supplements  the  bank.  Through  a 
long  process  of  evolution  the  bank  has  developed  as  a  means 
of  facilitating  the  exchange  of  commodities.  The  trust  com- 
pany is  a  still  further  step  in  the  same  process,  and,  in  a  highly 
organized  society,  it  meets  needs  which  the  bank  is  not  able 
to  supply. 

In  a  new  community  the  general  store  forms  the  centre  of 
the  business  life  of  the  place.  With  growth  and  increasing 
trade,  the  private  banker  sees  room  for  the  profitable  employ- 
ment of  his  funds.  The  state  or  national  bank  meets  the  needs 
of  further  growth.  Success  and  the  accumulation  of  wealth 
pave  the  way  for  the  trust  company.  The  bank  is  organized 
primarily  to  serve  the  needs  of  active  commercial  life;  the 
trust  company  handles  funds  in  less  active  circulation. 

It  is  customary  for  the  courts  to  designate  or  approve  certain 
trust  companies  as  depositories  for  funds  paid  into  court,  and 
the  effect  of  such  designation  or  approval  would  be  to  relieve 
executors,  trustees,  or  others  acting  in  a  fiduciary  capacity 
and  depositing  with  these  companies  from  liability  for  loss 
through  their  failure.  A  person  charged  with  due  care  in  the 
selection  of  a  depository  could  not  be  held  to  have  been  want- 
ing in  such  care  in  choosing  as  a  depository  a  trust  company 
which  the  court  has  itself  approved. 

The  powers  of  trust  companies  vary  in  different  states,  and 
when  they  are  created  by  special  legislation,  local  companies 
are  found  with  different  charter  privileges.  The  capital  and 
surplus  of  these  institutions  are  liable  for  their  acts  in  fiduciary 

1  Adapted  from  Kirkbride  and   Sterrett,  The  Modern  Trust  Company, 
PP-  1-13,  113,  114,  127,  143-146,  204,  205,  208.    The  Macmillan  Company. 

256 


DISTRIBUTION 


257 


capacities,  and  in  some  states  they  are  required  to  deposit  with 
one  of  the  state  departments  a  fund  as  a  special  guarantee. 
The  liability  assumed  is  generally  accepted  by  the  courts  in  lieu 
of  the  bonds  which  individuals  acting  in  similar  capacities  are 
required  to  give. 

The  development  of  trust  companies  in  the  United  States 
has  been  remarkably  rapid.  Since  1882,  when  the  first  legal 
authority  was  given  for  the  exercise  by  corporations  of  fidu- 
ciary powers,  they  have  steadily  grown  in  number  until  there 
are  now  more  than  fifteen  hundred,  distributed  as  follows: 


Alabama   30 

Arizona  9 

Arkansas 38 

California  24 

Colorado   16 

Connecticut    31 

Delaware    12 

District  of 

Columbia    ....  5 

Florida    9 

Georgia   25 

Idaho   10 

Illinois   75 

Indiana    108 

Iowa 29 

Kansas 4 

Kentucky    42 

Louisiana    .  22 


Maine    39 

Maryland    21 

Massachusetts     ...  56 

Michigan     6 

Minnesota    4 

Mississippi    19 

Missouri    49 

Montana   7 

Nebraska    13 

Nevada    i 

New  Hampshire  . .  4 

New  Jersey  86 

New  Mexico  10 

New  York  78 

North  Carolina  ...  38 

North  Dakota  ....  5 

Ohio  60 

Oklahoma  .  10 


Oregon    20 

Pennsylvania     ....  260 

Rhode  Island n 

South  Carolina  ...  17 

South  Dakota  ....  12 

Tennessee    73 

Texas 52 

Utah 9 

Vermont  26 

Virginia 19 

Washington    20 

West  Virginia  ....  22 

Wisconsin 9 

Wyoming    5 

Hawaii    5 


Total 


1555 


Their  business  in  all  departments  has  shown  a  steady  in- 
crease, and  the  trust  companies  of  the  United  States  to-day 
carry  deposits  amounting  to  over  $3,858,300,000.  Net  de- 
posits in  the  7397  national  banks  aggregate  $5,891,670,000. 

In  some  states  commercial  banking  and  trust  powers  are 
exercised  by  the  same  companies.  In  such  cases,  separate  de- 
partments are  maintained  for  the  various  classes  of  business. 
Another  method  is  for  the  same  individuals  to  organize  a 
national  bank  and  a  trust  company,  the  former  under  national 
and  the  latter  under  state  laws. 

The  securities  company  or  trust  company  organized  under 
state  laws  and  controlled  by  a  national  bank  with  the  stock 
interest  in  the  former  distributed  among  the  owners  of  the 
stock  of  the  bank  and  evidenced  by  indorsement  on  its  certifi- 
cates is  still  another  expedient  which  has  been  resorted  to  in 
order  to  enable  a  closely  affiliated  and  controlled  organization 


258      NATURE  AND  FUNCTIONS  OF  TRUST  COMPANIES 

to  exercise  legitimate  functions  which  are,  however,  outside 
the  province  of  a  national  bank. 

The  earning  power  of  trust  companies  has  equalled  and 
even  exceeded  that  of  the  banks,  and  the  stock  of  those  com- 
panies which  are  well  established  and  doing  a  flourishing  busi- 
ness sells  at  such  a  premium  that  investment  in  it  at  its  market 
value  gives  a  very  low  return. 

Trust  company  failures  have  been  few  and  far  between,  and 
where  they  have  occurred  they  can  be  traced  to  a  disregard 
of  sound  banking  principles  and  to  the  assumption  of  unwar- 
ranted risks.  Even  in  the  case  of  companies  which  have  failed 
there  is  no  record  of  any  impairment  of  trust  funds,  what- 
ever loss  there  was  having  been  borne  by  the  stockholders  and, 
to  a  less  degree,  by  the  depositors.  This  fact,  the  result  of 
the  absolute  separation  of  trust  assets  from  assets  belonging 
to  the  company,  is  the  strongest  argument  for  the  employment 
of  trust  companies  in  fiduciary  capacities,  and  explains  their 
rapid  growth  in  popular  favor. 

The  literature  put  out  by  these  institutions  invariably  recites 
the  advantages  to  be  gained  by  dealing  with  them  instead  of 
with  individuals.  The  following  is  a  good  example  jf  such 
reasoning : 

THE  ADVANTAGES  OF  A  TRUST  COMPANY  AS  TRUSTEE 

A  trust  company  is  preferable  to  individual  trustees,  because  it 
possesses  every  quality  of  desirability  which  the  individual  lacks, 
to  wit: — 

(1)  Its  permanency;  it  does  not  die. 

(2)  It  does  not  go  abroad. 

(3)  It  does  not  become  insane. 

(4)  It  does  not  imperil  the  trust  by  failure  or  dishonesty. 

(5)  Its  experience  and  judgment  in  trust  matters  are  beyond 

dispute. 

(6)  It  never  neglects   its  work  or  hands  it  over  to  untrust- 

worthy people. 

(7)  It  does  not  refuse  to  act  from  caprice  or  on  the  ground  of 

inexperience. 

(8)  It  is  invariably  on  hand  during  business  hours  and  can  be 

consulted  at  all  times. 

(9)  Its  wide  experience  of  trust  business  and  trust  securities 

is  invaluable  to  the  estate. 


ADVANTAGES  259 

(10)  It  is  absolutely  confidential. 

(n)  It  has  no  sympathies  or  antipathies  and  no  politics. 

(12)  It  can  be  relied  upon  to  act  up  to  its  instructions. 

(13)  It  does  not  resign. 

(14)  All   new   investments   of  value   suitable   for   trust   estates 

are  offered  in  the  first  instance  to  trust  companies,  and 
in  that  way  it  has  a  choice  of  valuable  security;  and  as 
its  purchases  are  on  a  scale  of  magnitude,  it  can 
usually  buy  at  a  rate  which  is  lower  than  that  at  which 
the  individual  trustee  can  purchase. 

The  most  common  objection  to  the  appointment  of  corporate 
trustees  is  thus  stated  by  Augustus  Peabody  Loring,  Esq. : 

The  trust  companies,  which  have  of  late  years  become  so  numerous, 
to  a  considerable  extent  do  away  with  the  element  of  personal  risk 
attaching  to  an  individual  trustee;  but  they  lack  the  advantages  of 
personal  management.  These  companies  sometimes  fail  from  im- 
proper management  as  utterly  as  individuals  do,  and  as  a  rule  the 
lack  of  personal  management  results  in  securing  the  minimum  re- 
turn only  on  the  amount  invested,  and  lacks  the  great  advantages 
often  secured  by  the  able  personal  oversight  of  individual  trustees. 

The  question,  after  all,  comes  back  to  the  personal  qualifi- 
cations of  corporate  officers  and  individuals.  If  the  former 
are  less  capable  than  the  latter,  the  fault  is  with  the  particular 
company  —  not  the  system,  and  if  interest  returns  are  some- 
times less  under  corporate  management,  this  fact  is  more  than 
equalized  by  the  added  safety  to  the  corpus  of  the  estate. 

A  "  Trustee  Company  "  has  been  suggested  as  a  proper  title 
for  the  company  doing  a  legitimate  trust  business,  and  is  the 
name  used  in  Australia  and  in  New  Zealand.  In  some  states 
the  use  of  the  word  "  trust "  in  corporate  titles  is  now  regu- 
lated by  law.  Confusion  has  arisen  in  the  popular  mind  be- 
tween the  trust  company  and  the  trusts  or  industrial  combina- 
tions. 

The  usual  functions  of  a  trust  company  are:  banking  in  a 
more  or  less  limited  form,  execution  of  corporate  trusts,  execu- 
tion of  individual  trusts,  care  of  securities  and  valuables.  In 
addition,  other  functions  are  sometimes  exercised,  such  as  life, 
title,  and  fidelity  insurance,  and  the  business  of  becoming 
surety.  The  earlier  companies  in  the  United  States  were  char- 
tered to  manage  individual  estates  only  and  to  act  in  certain 


200       NATURE  AND  FUNCTIONS  OF  TRUST  COMPANIES 

fiduciary  capacities;  the  recent  development  of  the  trust  com- 
pany has  been  in  the  direction  of  banking  functions  and  cor- 
porate trust  business. 

It  is  worthy  to  note  that  the  life  insurance  companies  which 
originally  secured  trust  powers  have,  with  but  few  exceptions, 
given  up  their  life  insurance  business,  and  that  most  of  the 
fidelity  insurance  and  surety  business  is  given  over  to  com- 
panies which  now  make  a  specialty  of  such  risks.  The  fact 
is  being  recognized  that  the  assumption  of  vast  risks  contingent 
on  future  occurrences  is  not  compatible  with  the  absolute  se- 
curity which  is  essential  in  the  transaction  of  legitimate  trust 
business. 

BANKING 

The  banking  functions  of  trust  companies  may  include  any 
or  all  of  the  following: 

The  receipt  of  money  deposits  payable  on  demand  and  sub- 
ject to  check,  or  payable  at  a  fixed  date,  or  according  to  special 
agreement.  Interest  is  usually  allowed  on  all  deposits  above 
a  fixed  maximum  amount  or  on  the  total  sum. 

Money  advances  secured  by  the  hypothecation  of  stocks, 
bonds,  life  insurance  policies,  bonds  and  mortgages,  or  other 
personal  property. 

Real  estate  loans,  secured  by  bond  and  mortgage.  It  is  cus- 
tomary to  loan  not  over  two-thirds  of  the  value  of  improved 
property;  when  the  property  is  unimproved,  not  more  than 
half. 

Discounting  paper  is  engaged  in  principally  by  companies 
transacting  a  commercial  banking  business.  The  purchase  of 
unsecured  paper  is  permitted  in  some  states  where  discount- 
ing is  not  allowed. 

The  purchase  and  sale  of  securities. 

Trust  companies  sometimes  guarantee  issues  of  bonds,  or 
at  least  set  their  stamp  of  approval  upon  them. 

The  issue  or  guarantee  of  letters  of  credit,  and  the  trans- 
action of  a  foreign  exchange  business. 

The  care  of  savings  deposits.  For  this  purpose  a  separate 
department  is  usually  maintained. 


TRUSTEE  UNDER  MORTGAGE  261 

CORPORATE  TRUSTS 

Among  the  most  important  functions  of  a  trust  company 
are  those  relative  to  the  business  of  other  corporations : 

Of  late  years  the  trust  companies  in  the  Eastern  cities  have  been 
selected  as  trustees  instead  of  individuals  whenever  the  law  of  the 
State  where  the  property  was  situated  allowed  such  selection. 
Trust  companies  have  manifold  advantages  over  individuals  in  such 
a  relationship;  they  do  not  die;  the  large  amount  of  financial  busi- 
ness which  they  daily  transact  provides  them  with  the  machinery 
for  such  purposes;  while  their  well-known  names  stand  as  evidence 
to  the  purchasing  public  that  at  least  the  necessary  formalities  have 
been  complied  with.  Beyond  that  responsibility  the  trustees  of  cor- 
poration mortgages  usually  assume  none. 

In  recent  years  the  trust  companies  have  shown  a  tendency,  when 
acting  as  mortgage  trustees,  to  recognize  a  greater  moral  responsi- 
bility than  they  at  first  were  willing  to  bear.  Trust  companies  did 
not,  of  course,  intend  to  appear  as  in  any  way  guaranteeing  the 
bonds  to  which  they  certified,  though  that  seems  often  to  have  been 
the  erroneous  opinion  of  the  unthinking;  but  trustees  now  acknowl- 
edge themselves  bound  within  the  limits  of  the  mortgage  to  use 
their  influence  to  protect  the  interest  of  the  bondholders.  A  trust 
company  which  should  now  allow  the  issue  of  unsecured  bonds  be- 
cause of  some  glaring  defect  in  the  language  of  the  mortgage,  would 
not  longer  be  morally  excused  by  financial  opinion,  though  perhaps 
held  technically  innocent.1 

As  trustee  under  corporate  mortgages  and  trust  deeds,  the 
trust  company  acts  for  the  bondholders.  It  is  customary  for 
it  to  authenticate  each  bond  issued  subject  to  the  provisions  of 
the  mortgage,  to  represent  the  bondholders  in  case  of  default, 
and  to  exercise  such  other  functions  as  may  be  provided  in 
the  mortgage. 

A  generation  ago  it  was  customary  for  a  railroad  to  name 
one  or  more  individuals  as  trustees  of  the  mortgages  executed 
to  secure  bond  issues.  The  development  of  trust  companies 
and  their  manifest  advantages  over  individuals  in  such  a 
capacity  has  resulted  in  their  absorbing  almost  all  this  busi- 
ness. Trust  companies  are  now  generally  appointed  as  trus- 
tees in  corporation  mortgages,  and  are  also  often  named  to 
succeed  individuals  who  have  died  or  resigned.  The  appoint- 

1  Thomas  L.  Greene,  Corporation  Finance,  p.  59. 


262      NATURE  AND  FUNCTIONS  OF  TRUST  COMPANIES 

ment  is  one  of  the  most  important  and  far  reaching  which  the 
trust  company  can  accept.  Its  name  and  reputation  serve  as 
an  assurance  that  the  transaction  is  a  regular  one,  and  entered 
into  in  good  faith.  Although  the  modern  corporation  mort- 
gage is  usually  explicit  in  its  terms  to  the  effect  that  the  trus- 
tee in  no  way  guarantees  the  value  of  the  security  and  assumes 
no  liability  except  for  its  own  negligence,  yet  the  intimate 
connection  between  the  trustee  and  the  borrowing  corporation 
in  the  minds  of  investors  makes  it  necessary  that  care  be  taken 
not  to  assume  trusteeships  which  may  lead  to  a  wrong  use  of 
the  name  and  credit  of  the  trust  company. 

As  trustee  under  mortgages  securing  bond  issues,  the  title 
to  the  mortgaged  property  is  vested  in  the  trust  company  for 
the  benefit  of  the  security  holders.  The  corporation  owning 
the  mortgaged  property  retains  physical  possession  of  it  so 
long  as  the  terms  of  the  obligation  are  complied  with,  except 
in  the  case  of  securities  pledged,  which  are  usually  lodged  with 
the  trustee.  In  case  of  default,  however,  it  devolves  upon  the 
trustee  to  protect  the  interests  of  the  bondholders,  and  this 
may  necessitate  the  foreclosure  of  the  mortgage  and  sale  of 
the  property. 

As  fiscal  agent  it  dispenses  coupon  and  interest  payments 
on  bond  issues,  and  dividends  on  stock.  It  receives  sums  set 
aside  as  sinking  funds  to  provide  for  the  retirement  of  obliga- 
tions at  maturity,  or  when  bonds  are  subject  to  redemption, 
draws  the  specified  amount  by  lot  and  pays  the  principal. 

As  registrar  the  trust  company  authenticates  certificates  of 
stock  and  bonds  in  order  to  prevent  an  over-issue,  and  to 
reduce  the  chance  of  loss  or  theft.  As  transfer  agent,  the 
company  attends  to  perfecting  transfers  of  ownership  for 
stock  and  bond  issues  or  parts  thereof. 

The  New  York  Stock  Exchange,  like  most  other  stock  ex- 
changes, in  its  constitution  requires  that  all  active  listed  stocks 
must  be  registered.  This  Exchange  also  requires  that  a  trust 
.company  or  other  agency  shall  not  at  the  same  time  act  as 
registrar  and  transfer  agent  of  the  same  corporation.  In  the 
popular  mind,  and  even  in  the  minds  of  some  trust  company 
officers,  the  difference  between  the  duties  of  the  two  positions 
has  been  more  or  less  confused.  Both  have  been  created  to 


INDIVIDUAL  TRUSTS  263 

safeguard  and  facilitate  the  passing  of  title  to  shares  of  stock, 
but  the  duties  of  a  transfer  agent  and  a  registrar  are  not 
synonymous;  they  are  distinctive.  One  is  called  upon  to  ex- 
amine and  give  clear  titles  to  property  transfers,  and  the  other 
is  merely  to  record  such  transfers. 

As  manager  of  underwriting  syndicates,  the  trust  company 
issues  the  prospectus  and  markets  the  securities  of  corporations 
which  are  being  launched,  or  of  established  companies  which 
are  putting  out  new  securities. 

In  railroad  and  other  reorganizations,  the  trust  company 
takes  a  prominent  part,  acting  both  as  a  depositary  for,  and  as 
a  representative  of,  the  committees  which  formulate  and  exe- 
cute the  plans  of  reorganization.  Its  officers  often  have  a 
large  share  in  the  preparation  of  such  plans. 

As  assignee  and  receiver,  the  trust  company  acts  in  the 
same  capacity  for  corporations  as  for  individuals  and  firms 
or  partnerships,  assisting  in  winding  up  insolvent  businesses 
and  in  conducting  embarrassed  ones. 

INDIVIDUAL  TRUSTS 

The  execution  of  individual  trusts  is  the  function  originally 
assumed  by  trust  companies.  The  various  other  forms  of 
business  which  are  now  engaged  in,  have,  with  the  exception  of 
life  insurance,  been  later  developments  of  the  trust  company 
idea.  The  earliest  power  granted  these  companies  was  to 
receive  moneys  or  other  property,  real  or  personal,  in  trust. 
The  trust  company  now  also  acts  as  executor  and  adminis- 
trator of  the  estates  of  decedents. 

As  executor  appointed  by  the  will  of  a  decedent,  it  takes 
out  letters  testamentary  upon  probate  of  the  will,  advertises, 
files  inventory  and  appraisement,  pays  debts,  collects  claims, 
makes  the  requisite  accounting  to  the  probate  or  orphans' 
court,  and  makes  distribution  of  the  estate  in  accordance  with 
the  terms  of  the  will  and  the  court's  decree. 

As  administrator  acting  under  appointment  of  the  register 
of  wills  or  probate  court,  it  performs  similar  duties,  distribut- 
ing the  estate  in  accordance  with  decedent's  will  if  there  is  one, 
or  if  there  is  none,  in  accordance  with  the  intestate  laws  of 


264      NATURE  AND  FUNCTIONS  OF  TRUST  COMPANIES 

the  state,  which  specify  the  order  of  succession  and  distribu- 
tive shares  in  the  case  of  estates  of  decedents  leaving  no  wills. 
There  are  different  kinds  of  administrators,  in  any  of  which 
capacities  a  trust  company  may  be  called  upon  to  act. 

As  trustee  under  will,  the  trust  company  carries  out  the 
provisions  of  the  will,  investing  and  managing  the  estate  or 
particular  fund  in  accordance  with  the  directions  of  the  testa- 
tor. As  such  it  may  hold  real  and  personal  property. 

As  trustee  under  deed  or  private  agreement,  a  contract  is 
entered  into  between  the  company  and  the  owner  of  the  prop- 
erty, by  which  the  title  to  the  property  is  vested  in  the  cor- 
poration subject  to  the  terms  recited  in  the  instrument.  Such 
deeds  of  trust  may  be  revocable  or  irrevocable.  Marriage 
settlements  are  frequently  made  in  this  way. 

The  trustee's  duty  in  investing  the  funds  is  a  double  one; 
namely,  to  invest  them  securely  so  that  the  principal  shall  be 
preserved  intact,  and  to  invest  them  as  productively  as  pos- 
sible under  his  powers,  so  that  they  shall  yield  the  best  rate  of 
interest  obtainable  for  the  benefit  of  the  person  or  persons 
entitled  to  the  income.  He  must  hold  the  scales  evenly,  re- 
garding scrupulously  his  duties  to  all  beneficiaries.  The  pop- 
ular idea  that  security  is  the  only  consideration  is  erroneous, 
as  the  trustee  is  equally  bound  to  invest  the  funds  as  profitably 
as  possible  and  cannot  neglect  one  duty  more  than  the  other. 
The  mistaken  impression  that  the  corporate  trustee,  even 
more  than  the  individual,  is  mindful  only  of  the  safety  of  the 
principal  and  entirely  loses  sight  of  the  question  of  income, 
has  arisen  from  the  restrictions  as  to  investments  imposed  by 
law,  and  frequently  also  by  the  will  or  trust  deed,  and  from 
the  fact  that  the  individual  executor  or  trustee,  rightly  or 
wrongly,  sometimes  assumes  risks  and  personal  liability  which 
the  proper  rules  of  a  trust  company  would  not  permit  it  to 
assume. 

The  executor  or  trustee  is  governed,  as  to  the  kinds  of 
investments,  by  the  directions  of  the  will  or  deed  of  trust. 
This  may  require  the  purchase  of  "  legal  investments  "  only, 
or  state  that  the  trustee  is  not  to  be  confined  to  securities  pre- 
scribed by  law,  or  give  specific  directions  as  to  the  classes  of 
securities  which  are  to  be  bought.  The  terms  of  such  docu- 


MISCELLANEOUS  FUNCTIONS  265 

ments  are  always  strictly  construed  by  the  courts;  if  no  direc- 
tions are  given,  the  trustee  is  expected  to  buy  only  "  legal " 
securities,  and  when  he  exceeds  his  powers  he  is  held  respon- 
sible for  any  loss.  Administrators  and  guardians  without 
broader  powers  given  by  will  are  obliged  to  invest,  except  at 
their  personal  risk,  in  such  securities  as  are  sanctioned  by  law 
or  directed  by  the  court. 

Some  states  prescribe  by  statute  the  securities  in  which  a 
trustee  may  invest.  "  Where  there  is  no  statute  or  decision 
of  the  highest  court  fixing  the  class  of  securities  in  which  a 
trustee  may  invest,  he  can  safely  follow  the  rule  prescribed  for 
the  investment  of  the  funds  of  savings  banks."  In  general, 
city,  State,  and  United  States  bonds,  first  mortgages  secured 
on  improved  real  estate  with  ample  margin,  are  among  the  in- 
vestments sanctioned  by  law.  As  to  real  estate,  stocks,  and 
first  mortgage  bonds  of  railroad,  manufacturing,  and  other 
corporations,  the  practice  varies  in  the  different  states.  Loans 
on  personal  property,  second  mortgages,  and  other  investments 
subject  to  prior  liens  or  of  a  speculative  character  are  excluded. 
All  investments  must  possess  "intrinsic"  value;  the  courts 
hold  trustees  liable  for  any  losses  from  speculative  risks  — 
but  any  gains  accrue  to  the  trust  estate. 

OTHER  FUNCTIONS 

The  trust  company  acts  as  guardian,  curator,  or  committee 
of  the  estates,  and  in  some  states,  of  the  persons  of  minors, 
those  who  are  insane  or  mentally  incompetent,  spendthrifts, 
drunkards,  and  any  other  persons  not  legally  qualified  to  take 
charge  of  their  own  affairs.  In  the  case  of  a  minor,  the  trust 
terminates  on  the  ward's  becoming  of  age ;  in  other  cases,  when 
the  disability  is  removed,  or  in  accordance  with  a  decree  of 
court.  These  appointments  are  frequently  made  by  order  of 
court,  and  to  it  accounting  must  be  made.  In  some  states  the 
company  is  styled  "  conservator  "  when  caring  for  the  estates 
of  persons  of  unsound  mind. 

When  acting  as  attorney  in  fact,  the  company  obtains  its 
authority  by  virtue  of  a  letter  of  attorney  which  usually  is  or 
can  be  recorded,  conveying  certain  definitely  specified  powers. 


266      NATURE  AND  FUNCTIONS  OF  TRUST  COMPANIES 

This  may  be  either  to  perform  a  single  act  —  such  as  to  satisfy 
a  mortgage  —  or  may  be  broader  and  continuing,  granting  au- 
thority to  sell  and  transfer  securities  and  collect  income.  A 
general  power  of  attorney,  as  the  term  indicates,  is  a  delega- 
tion to  another  of  the  general  powers  of  the  person  appointing 
—  as  to  payments,  collections,  transfers  of  property,  and  all 
transactions  of  a  business  nature. 

As  agent  merely,  the  company  takes  charge  of  property,  real 
or  personal,  for  its  owner,  but  such  agency  does  not  imply 
nor  ordinarily  include  authority  to  sell  or  convey  title.  More- 
over, trust  companies  as  agent  often  take  up  lines  of  business 
which  they  either  cannot  or  would  not  engage  in  on  their  own 
account.  Thus,  a  trust  company  can  act  as  agent  for  fire  or 
life  insurance  companies,  for  water,  gas,  and  other  public 
service  corporations.  In  new  communities  and  where  it  is 
difficult  to  find  responsible  representatives,  the  trust  company 
can  often  render  efficient  service  and  secure  a  steady  income 
without  risk  by  assuming  agencies  of  various  sorts. 

As  assignee  the  trust  company  takes  possession  of  the  prop- 
erty assigned  for  the  purpose  of  carrying  out  the  terms  of  the 
deed  of  assignment  in  the  interest  both  of  the  assignor  and 
the  creditors  of  the  assignor.  The  deed  of  assignment  is  an 
acknowledgment  of  an  embarrassed  or  insolvent  condition,  and 
the  efforts  of  the  assignee  are  directed  to  realizing  as  much  as 
possible  from  the  assets  intrusted  to  its  management. 

As  receiver,  the  duties  may  be  very  similar  to  those  of 
assignee,  although  they  are  usually  broader  in  scope.  The 
business  may  not  be  insolvent,  and  the  application  for  the  ap- 
pointment of  a  receiver  may  be  due  to  temporary  difficulties 
only.  By  such  an  appointment  the  property  is  preserved  intact 
and  equal  treatment  is  afforded  creditors.  An  able  receiver- 
ship often  results  in  the  adjustment  of  difficulties  and  the 
return  of  the  property  to  its  owners  on  a  paying  basis.  While 
in  the  case  of  assignee  the  appointment  is  by  the  individual, 
partnership,  or  corporation  executing  the  deed  of  assignment 
which  specifies  the  powers  and  duties  of  the  assignee,  in  the 
case  of  receiver  the  appointment  is  by  a  court  and  the  company 
so  appointed  acts  as  an  appointee  or  ministerial  officer  of  the 
court,  and  as  such  is  directly  subject  to  the  court's  orders. 


MISCELLANEOUS  FUNCTIONS  267 

A  trust  company  acting  as  receiver  is  better  able  than  an 
individual  to  furnish  additional  capital,  if  amply  secured,  and 
thus  successfully  to  meet  the  difficulties  which  withdrawal  of 
credit  and  restricted  capital  have  temporarily  brought  upon  an 
otherwise  prosperous  business.  The  courts  authorize  the  issue 
of  receivers'  certificates  to  provide  funds  for  purchase  of 
equipment  and  the  proper  maintenance  of  the  property  and  con- 
duct of  the  business  when  the  creditors  are  benefited  by  such 
expenditures.  Such  certificates  may  be  made  a  first  lien  on 
all  assets,  taking  precedence  even  of  mortgages  and  other  se- 
cured obligations.  The  receiver  thus  secures  the  capital  neces- 
sary to  make  the  property  more  productive  and  to  secure  the 
largest  return  from  the  business. 

As  custodian  or  depositary,  the  trust  company  sometimes 
holds  property  the  title  to  which  is  in  dispute,  delivering  the 
same  when  the  ownership  is  legally  determined. 

In  taking  charge  of  escrows  or  conditional  instruments  or 
deeds  delivered  to  a  third  party  until  the  condition  is  per- 
formed, the  trust  company  acts  in  a  similar  capacity,  as  the 
joint  representative  of  both  parties. 

The  trust  company  acts  as  the  representative  of  both  the 
living  and  the  dead  in  practically  every  legal  relation  in  which 
an  individual  is  qualified  to  act.  Its  function  is  not  only  to 
keep  intact  the  estate  of  which  it  has  charge,  but  to  look  to 
and  safeguard  the  interest  of  every  beneficiary. 

CARE  OF  SECURITIES  AND  VALUABLES 

The  functions  already  recited  have  resulted  in  the  assump- 
tion of  the  duty  of  caring  for  property  other  than  that  of  the 
estates  held  in  the  trust  department.  In  the  safe  deposit  de- 
partment, individual  safes  are  rented,  bulky  packages  —  not 
containing  stocks  or  bonds  —  are  received  on  storage,  certifi- 
cates of  deposit  covering  securities  are  issued,  and  provision 
is  made  for  access  to,  and  examination  of,  the  property  so 
deposited.  For  personal  property  received  on  storage,  the 
charges  are  either  according  to  bulk  or  value.  Wills  are 
usually  receipted  for  and  kept  without  charge. 


268      NATURE  AND  FUNCTIONS  OF  TRUST  COMPANIES 


The  examination  and  insurance  of  real  estate  titles  is  a  later 
development  often  found  in  connection  with  the  usual  trust 
functions. 

Fidelity  insurance  and  suretyship  providing  against  loss  by 
reason  of  the  dishonesty  of  individuals  and  the  non-perform- 
ance of  obligations,  contracts,  etc.,  have  often  been  combined 
with  the  various  forms  of  trust  company  activity.  They  are, 
however,  largely  passing  into  the  hands  of  corporations  espe- 
cially organized  for  the  transaction  of  such  business. 

COMPENSATION 

When  acting  as  trustee  under  corporation  mortgages,  a 
definite  charge  may  be  made  for  accepting  the  trust,  and  a 
fixed  amount  per  annum  thereafter  for  paying  coupons  and 
performing  other  duties.  For  the  certification  of  bonds  it  is 
usual  to  charge  fifty  cents  per  bond  in  the  case  of  large  issues, 
and  one  dollar  for  small  issues.  The  figures,  however,  vary 
in  different  places.  The  charge  for  certifying  the  bonds  may 
be  the  only  one,  although  an  additional  charge  is  usually  made 
for  counsel  fees.  In  case  of  default  and  consequent  fore- 
closure of  the  mortgage,  extra  payment  is  made  to  the  trustee 
covering  all  services  incident  to  the  foreclosure. 

For  the  disbursement  of  sinking  funds,  interest,  or  coupons, 
the  temporary  use  of  the  money  may  be  considered  adequate 
compensation,  if  the  amount  involved  is  large.  A  commission 
on  the  sum  distributed  or  a  fixed  amount  is  charged  when  act- 
ing as  fiscal  agent,  apart  from  duties  in  other  capacities.  For 
acting  as  registrar  or  as  transfer  agent  it  is  usual  to  make  a 
fixed  charge  per  annum,  based  on  the  amount  of  labor  in- 
volved. The  transfer  agent  is  usually  paid  about  twice  as 
much  as  the  registrar.  Compensation  for  acting  as  manager 
of  an  underwriting  syndicate  may  be  a  fixed  sum  or  a  commis- 
sion, according  to  the  provisions  of  the  underwriting  agree- 
ment. For  acting  as  depositary  under  plans  of  reorganization, 
assignee,  or  receiver,  a  lump  sum  is  usually  paid  covering  all 
services.  Agency  work  of  various  sorts  is  paid  for  in  accord- 


GOVERNMENT   REGULATION  269 

ance  with  the  usual  practice  in  the  business  which  is  under- 
taken; a  fixed  sum,  or  a  fixed  sum  and  a  commission,  or  a 
commission  only,  may  be  received. 

The  trust  company  is  in  a  position  to  render  valuable,  and 
often  indispensable,  aid  to  its  corporate  clients.  Large 
amounts  being  involved,  the  great  railroad  and  industrial  cor- 
porations are  willing  to  pay  well  for  such  services.  Corporate 
trust  business  has,  consequently,  been  a  profitable  field  for  the 
trust  companies. 

GOVERNMENT  REGULATION 

An  examination  of  the  laws  of  the  various  states  is  inter- 
esting as  showing  the  attempts  which  are  being  made  at  regu- 
lation. Most  of  these  laws  have  been  enacted  within  recent 
years  and  to-day  there  are  but  few  States  which  do  not  have 
such  statutes  on  their  books. 

The  step  which  Massachusetts  first  took  in  requiring  a  legal 
reserve  to  secure  deposits  has  been  followed  by  similar  action 
in  other  states.  In  general,  the  wisdom  of  prohibiting  com- 
panies which  engage  in  the  care  of  estates  from  assuming  ex- 
cessive risks  is  becoming  better  recognized.  The  promotion 
and  underwriting  of  commercial  ventures  and  the  assumption 
of  unknown  risks  are  functions  not  compatible  with  the  proper 
exercise  of  the  duties  of  trustee  or  executor. 

The  supervision  of  trust  companies  by  the  separate  states 
provides  an  elastic  system  to  supplement  the  rigidly  guarded 
powers  of  the  national  banks,  and  can  adapt  itself  to  changing 
conditions  and  enlarging  needs,  leaving  for  solution  according 
to  the  requirements  of  each  section  of  the  country  such  ques- 
tions as  proper  functions,  reserves,  and  the  authority  to  estab- 
lish branch  offices. 


CHAPTER  XVI 
SAVINGS  BANKS 

1  THE  savings  bank  works  with  those  unacquainted  with  the 
ways  of  business  and  who  could  not  single  handed  take  good 
care  of  their  money,  or  invest  it  safely  or  profitably.  The 
bank  of  discount  is  generally  managed  by  business  men  versed 
in  the  ways  of  business,  acquainted  with  monetary  affairs,  and 
able  to  conduct  financial  operations  with  intelligence.  They 
combine  their  capital  in  order  to  make  it  effective ;  the  savings 
bank  combines  savings  in  order  to  make  them  capital,  and  as 
such  to  acquire  a  power  impossible  to  the  scattered  savings. 

The  savings  bank  is  for  the  saver;  its  funds  are  invested 
permanently,  while  the  business  bank  opens  its  doors  to  busi- 
ness men  and  loans  rather  than  invests  its  funds,  and  for  a 
short  time  only.  The  latter  deals  with  borrowers  rather  than 
savers,  and  serves  for  hire.  The  one  serves  best  by  keeping 
—  the  other  by  lending.  One  aims  at  profit,  while  the  other 
never  makes  (or  should  make)  profit  an  end.  The  savings 
bank  is  the  receiving  reservoir  for  the  little  springs,  the  bank 
of  discount  is  the  distributing  reservoir  for  accumulated 
capital. 

We  must  get  the  last  idea  clearly  in  mind  or  we  get  a  mis- 
conception of  the  savings  bank.  However  much  the  element 
of  interest  may  figure  in  the  management,  and  whether  we 
pay  depositors  4  per  cent,  or  3  per  cent.,  or  no  interest  at  all, 
the  accumulation  of  interest  is  not  to  be  compared  in  impor- 
tance with  the  accumulation  of  principal. 

No  man  ever  acquired  riches  at  4  per  cent.  In  fact,  4  per 
cent,  upon  small  deposits  is  so  trifling  a  matter  that  it  may  be 
ignored  in  considering  the  greater  value  of  the  increase  of 
capital.  However  desirable  the  accumulation  of  interest  may 

1  Adapted  from  W.  H.  Kniffin,  The  Savings  Bank  and  Its  Practical 
Work,  pp.  54-75.  The  Bankers  Publishing  Company.  New  York,  1912. 

270 


TRUSTEE  SAVINGS  BANKS  271 

be  (and  this  in  the  course  of  years  is  considerable),  the  chief 
end  and  aim  of  the  savings  bank  should  be  the  accumulation 
of  principal. 


CLASSIFICATION  OF  SAVINGS  BANKS 

We  may  roughly  classify  savings  institutions  into:  First, 
mutual  (trustee),  or  philanthropic;  second, -stock  (including 
"  savings  and  trust  companies  ")  ;  third,  co-operative,  or  demo- 
cratic, as  exemplified  in  the  co-operative  banks  of  Europe. 
The  first  are  usually  managed  by  a  self -perpetuating  body  of 
trustees,  who  do  not  share  the  earnings ;  the  second  are  man- 
aged by  the  directors  elected  by  the  stockholders ;  the  third  are 
managed  by  officials  elected  by  the  members. 

A  second  classification  may  be  made  into  public  and  private 
institutions ;  the  first  includes  the  postal  and  municipal  banks ; 
the  private  embraces  the  mutual,  stock,  and  co-operative.  A 
third  classification  may  still  be  made  into  the  "  unit "  and  the 
chain  system.  In  the  unit  system  the  bank  is  an  independent 
entity  and  has  no  connection  (aside  from  a  managerial  stand- 
point) with  any  other  bank.  The  banks  of  the  United  States 
are  all,  excepting  the  Postal  Savings  Banks  and  a  few  branch 
savings  banks,  of  this  character.  In  the  second,  the  bank  is 
but  a  part  of  a  chain,  as  in  the  postal  system,  the  municipal 
banks  of  Germany,  and  the  co-operative  credit  banks  of  Eur- 
ope. We  shall  briefly  review  each  system. 

TRUSTEE  SAVINGS  BANKS 

The  original  savings  bank  is  the  trustee  bank.  As  Hamil- 
ton says,  "  It  stands  for  the  attempt  on  the  part  of  the  well- 
to-do  to  improve  the  condition  of  the  poorer  classes,  and  in- 
volves a  self-sacrificing  service  on  the  part  of  a  few  in  the 
interest  of  the  many."  While  many  of  the  early  savings  banks 
partook  of  this  character,  others  were  organised  from  purely 
selfish  motives  and  were  characterised  by  bad  management  and 
bad  faith  from  the  start.  A  study  of  savings  bank  frauds  will 
amply  bear  out  this  statement. 

The  "  spirit  of  commercialism "  hereafter  spoken  of  has 


272  SAVINGS  BANKS 

invaded  the  domain  of  the  mutual  savings  bank  and  it  cannot 
in  truth  be  said  that  some  of  the  newer  banks  were  organised 
from  any  spirit  of  philanthropy,  although  the  management  as 
a  whole  may  be  above  suspicion  and  honorable  in  the  highest 
degree. 

But,  however  this  may  be,  the  mutual  savings  bank  is  a 
product  of  the  East  and  promises  to  remain  so  in  spite  of  the 
fact  that  some  of  the  Western  states  have  very  good,  if  not 
excellent,  savings  bank  laws. 

The  distinguishing  characteristic  of  the  trustee  savings  bank 
is  mutuality.  All  the  earnings  of  the  bank,  less  reasonable 
administrative  expenses  and  the  apportionment  to  surplus  or 
guaranty  fund,  are  divided  among  the  depositors  in  the  form 
of  interest. 

One  or  two  features  of  the  mutual  bank  may  be  mentioned. 
First,  the  investments  of  such  institutions  are  usually  carefully 
restricted,  looking  primarily  to  the  element  of  safety;  and  as 
long  as  the  trustees  keep  their  funds  so  invested  they  cannot 
be  held,  either  in  law  or  morals,  responsible  for  losses.  Sec- 
ond, the  predominancy  of  the  mortgage  loan.  The  nature  of 
the  deposits  being  more  or  less  permanent,  investments  of  a 
permanent  character  may  be  made  without  fear  of  a  sudden 
demand  for  their  return  on  the  part  of  depositors;  and  to  safe- 
guard the  banks  from  such  unexpected  cal^s,  quite  generally 
trustee  banks  are  permitted  by  law  to  require  notice,  the  usual 
time  being  either  sixty  or  ninety  days.  The  third  distinguish- 
ing feature  is  the  self-perpetuation  of  the  board  of  managers. 
No  amount  of  money  can  buy  a  man's  way  into  a  mutual  sav- 
ings bank.  He  cannot,  as  in  stock  concerns,  buy  enough 
stock  to  vote  himself  into  office  — he  can  only  gain  office  as 
the  other  men  advocate  his  cause.  And,  on  the  contrary,  he 
cannot  be  voted  out  of  office.  Only  an  act,  such  as  bank- 
ruptcy (which  voids  his  office),  can  affect  him,  and,  like  a 
Supreme  Court  judge,  he  is  appointed  during  good  behavior. 

The  greatest  weakness  of  the  trustee  bank  is  this :  Lacking 
the  "  essential  element "  that  prompts  men  to  undertake  such 
ventures  (profit),  it  does  not  appeal  to  the  average  man  of 
means  unless  he  is  sentimentally  inclined;  and  not  being  in- 
dispensable to  trade  and  commerce,  like  a  bank  of  discount, 


STOCK  SAVINGS  BANKS  273 

it  does  not  come  to  be  a  commercial  necessity.  Even  in  a 
great  State  like  New  York  we  find  twenty-eight  counties  with 
no  savings  banks.  And  in  many  of  these  counties  there  are 
large  and  thriving  towns  and  cities.  Thus  the  city  of  James- 
town, with  over  30,000  population,  has  no  savings  banks; 
while  Elmira,  with  over  35,000  population,  has  but  one,  and 
that  with  but  half  a  million  assets. 

From  the  viewpoint  of  intensive  results,  as  tested  by  the 
volume  of  patronage  accorded  these  institutions,  a  perusal  of 
the  statistics  will  demonstrate  that  in  some  places  the  trustee 
bank  has  had  a  remarkable  record.  For  instance,  in  Maine, 
a  sparsely-settled  State,  and  largely  of  a  rural  nature,  we  find 
one  savings  account  to  every  3  of  the  population.  More  re- 
markable is  Vermont,  the  "  Green  Mountain  State,"  where 
natural  conditions  would  seem  to  be  much  more  hostile  to  such 
development,  we  find  30  per  cent,  of  the  population  having 
savings  bank  accounts.  New  Hampshire  has  an  account  for 
every  2.^/2  of  the  population,  while  Massachusetts  heads  the 
list,  with  seventy-five  out  of  every  hundred.  New  York  has 
one  to  every  three. 

"  In  seeking  an  explanation  of  this  remarkable  success  of 
the  trustee  system,"  says  Hamilton,  "  we  are  reminded  that 
New  England  is  singularly  separate  and  distinct  in  its  cus- 
toms, habits  and  ideals  from  the  rest  of  the  country.  Not- 
withstanding the  large  foreign  population,  the  dominant  type 
is  more  homogeneous  and  more  Anglo-Saxon  than  it  is  in  any 
other  section,  and  therefore  fixed  customs  have  been  more 
rigid  and  controlling.  Among  the  ideals  behind  the  customs 
and  institutions  must  be  noted  a  stern,  Puritanical  sense  of 
simple  living,  industry  and  providence,  and  this  spirit  is  so 
strong  as  to  be  well  calculated  to  give  color  and  direction  to 
the  philanthropic  impulse.  There  is  also  an  unusual  amount 
of  public  spirit,  of  collective  rather  than  a  neighborly  charac- 
ter, as  seen  in  the  institution  of  the  town  meeting." 

STOCK  SAVINGS  BANKS 

The  stock  savings  bank,  where  it  is  a  savings  bank,  and 
not  a  bank  of  discount  under  a  savings  title,  differs  in  no  essen- 


274  SAVINGS  BANKS 

tial  degree  from  the  mutual  institution.  The  mutual  bank  be- 
longs to  the  depositors;  the  stock  bank  to  the  stockholders. 
The  mutual  bank  pays  dividends  to  depositors  only;  the  stock 
bank  pays  dividends  to  both  stockholders  and  depositors.  The 
stock  bank  does  not  pretend  to  be  philanthropic  in  its  manage- 
ment. It  is  purely  a  business  proposition,  and  where  the  in- 
vestments are  of  the  accepted  savings  bank  type,  it  can  justly 
claim  to  be  on  a  par  with  its  mutual  friends,  provided,  of 
course,  that  it  measures  up  to  the  standard  in  its  management. 

As  is  implied  in  the  term  "  stock,"  it  issues  capital  shares 
and  pays  dividends  thereon.  It  has,  therefore,  the  added  pro- 
tection of  the  stockholder's  liability, 'which,  together  with  the 
accumulated  surplus,  affords  the  element  of  strength  so  neces- 
sary in  all  financial  concerns.  It  usually  pays  the  depositors 
a  stipulated  rate  of  interest,  and  the  profits  beyond  this  belong 
to  and  are  distributed  to  the  stockholders  as  dividends.  The 
partnership  idea  is  entirely  lacking,  and  the  depositors  get  \vhat 
they  bargain  for,  while  the  surplus  goes  to  those  who  invest, 
not  necessarily  their  savings,  but  their  capital,  and  assume  all 
risks  of  the  business.  It  could  not  in  law  or  equity  "  scale 
down  "  its  deposits  to  make  good  any  losses  —  a  feature  pecu- 
liar to  the  mutual  institution. 

In  this  respect  one  thing  is  certain :  In  so  far  as  safety  is 
concerned,  especially  in  a  young  bank,  the  stock  bank  with 
the  stockholders'  liability  is  surely  superior  to  the  mutual,  un- 
less the  trustees  of  the  latter  are  of  such  high  order  and  of 
such  financial  worth  as  to  be  able  and  willing  to  assume  the 
burden  of  any  losses  that  may  accrue  until  the  surplus  or  guar- 
anty fund  affords  ample  protection.  This  was  the  trouble  in 
the  early  days  of  the  mutual  savings  banks  in  England. 

GUARANTY  SAVINGS  BANKS 

New  Hampshire  is  the  only  state  in  which  "  guaranty  sav- 
ings banks  "  are  found.  These  are  a  combination  of  mutual 
and  stock  —  a  cross  between  the  two.  They  do  not  transact 
a  commercial  business,  being  strictly  savings  banks  in  their 
functions,  yet  having  "  special  deposits,"  which  to  all  intents 
and  purposes  are  capital  stock.  "  The  guaranty  savings  bank 


MUNICIPAL  SAVINGS  BANKS  275 

differs  from  the  ordinary  mutual  savings  bank  in  that  it  has 
capital  stock  or  special  deposits,  as  they  are  called.  It  pays 
a  certain  stipulated  rate  of  interest  to  its  general  depositors 
and  any  surplus  of  earnings  above  this  dividend  is  available 
for  dividends  on  the  capital  stock  or  special  deposits.  These 
special  deposits  constitute  a  guaranty  fund  for  the  general  de- 
positors, and  the  charter  ordinarily  stipulates  that  the  special 
deposits  shall  always  equal  10  per  cent,  of  the  deposits." 

Such  institutions  are  savings  banks  in  every  sense  of  the 
word,  but  the  strictly  mutual  feature  is  lacking  in  the  special- 
ising of  part  of  the  deposits  and  paying  a  higher  rate  of  inter- 
est on  these  deposits.  In  New  York  State  savings  banks  can- 
not take  a  "  special  deposit,"  but  in  New  Hampshire,  in  return 
for  the  higher  interest  rate,  the  special  depositors  assume  all 
the  risk  of  loss  or  depreciation,  and,  as  in  the  case  of  stock 
concerns,  they  would  be  the  first  to  suffer  in  the  event  of  in- 
solvency. 

MUNICIPAL  SAVINGS  BANKS 

This  form  of  savings  banks  properly  belongs  to  a  strong 
class  of  municipalities.  They  can  only  thrive  in  places  where 
the  local  spirit  is  strong,  the  local  government  pure,  and  where 
the  local  officials  are  accustomed  to  wield  a  large  measure  of 
authority.  Accordingly,  they  have  come  into  being  and  met 
with  success  in  those  countries  where  the  early  history  of  the 
town  made  a  large  measure  of  local  autonomy  a  necessity. 
Towns  of  this  class  possess  the  public  spirit  and  the  intelligent 
administration  required  for  the  success  of  such  a  public  ven- 
ture. They  also  possess  a  fund  of  gratuitous  public  service 
among  the  citizens  which  may  be  drawn  upon  when  occasion 
requires. 

Such  banks  are  found  in  Austria,  France,  Italy,  Denmark, 
Sweden,  and  Japan.  The  best  examples  are  to  be  found  in 
Germany,  where  they  have  been  in  operation  for  a  long  period 
of  years.  Savings  institutions  exist  here  at  present  in  great 
variety  and  number,  including  State  or  Province  Savings 
Banks,  City  Savings  Banks,  Township  Savings  Banks,  County 
Savings  Banks,  Bezirk  (District)  Savings  Banks,  Private  Sav- 
ings Banks,  and  Co-operative  Savings  Banks. 


276  SAVINGS  BANKS 

These  banks  have  some  19,000,000  pass  books  out  and  their 
deposits  amount  to  13,500,000,000  marks  ($3,213,000,000). 
These  deposits  are  practically  all  guaranteed  by  the  various 
municipalities  of  the  Empire,  which  condition  forms  a  bul- 
wark of  confidence  in  the  security  of  private  wealth  and  earn- 
ings that  cannot  be  shaken  by  hard  times,  panics,  bank  fail- 
ures, etc. 

PEOPLE'S  BANKS 

The  co-operative  banks  of  Europe,  otherwise  called  "  Peo- 
ple's Banks,"  are  essentially  savings  banks,  in  that  they  depend 
for  their  working  capital  upon  the  accumulated  savings  of 
their  members.  The  aims  of  these  banks  are  first  economic, 
to  enable  the  economically  weak  to  make  themselves  financially 
strong  by  the  power  of  combination;  second,  moral,  to  bring 
the  members  together  in  a  unity  of  interests  and  to  develop 
character  by  making  thrift  and  good  habits  the  groundwork 
of  their  operations;  third,  educational,  to  train  in  business 
methods  and  in  the  handling  of  money  those  whose  scope  has 
been  narrow  and  whose  experiences  have  been  few  in  this 
regard. 

In  the  establishment  of  these  banks,  the  cardinal  rules  have 
been:  Maximum  of  responsibility,  minimum  of  risk,  maxi- 
mum of  publicity.  To  secure  the  maximum  of  responsibility, 
unlimited  liability  has  been  accepted  by  the  members  in  many 
cases;  that  is,  each  one  pledging  his  all  for  the  good  of  all; 
and,  second,  to  secure  the  minimum  of  risk,  character  is  made 
the  basis  of  membership  and  good  habits  the  prime  requisite 
for  membership.  No  investments  are  made  in  speculative  en- 
terprises, and  the  purposes  for  which  the  money  is  borrowed 
are  closely  inquired  into  and  due  care  taken  that  the  funds 
shall  be  applied  for  such  purposes  only.  To  secure  the  maxi- 
mum of  publicity  the  action  of  the  bank  in  all  matters  is  given 
the  widest  publicity  possible  in  order  that  the  work  may  have 
public  inspection. 

The  result  of  these  simple  rules  has  been  that  the  poor  have 
proven  as  good,  if  not  better,  creditors  than  the  rich;  for  once 
losing  credit  they  can  never  regain  it  except  by  the  slow  pro- 
cess of  years  of  good  behavior. 


LOCALIZATION  277 

The  great  pioneers  in  the  "  People's  Banks  "  were  Raiffeis- 
en  and  Schulze-Delitzsch.  They  fully  appreciated  that  any 
system  that  would  succeed  must  descend  to  the  level  of  its 
beneficiaries  and  they  have  admirably  adapted  the  co-operative 
idea  of  banking. 

THE  LOCALIZATION  OF  SAVINGS  BANKS  IN  THE  UNITED 

STATES 

The  home  of  the  mutual  savings  bank  is  in  the  East,  where 
it  began  operations  in  1816,  and  may  even  be  said  to  be  in  the 
Eastern  States;  for  west  of  Buffalo  and  south  of  Baltimore, 
we  find  only  21  savings  banks  of  the  mutual  character.  Out 
of  647  savings  banks  of  the  mutual  type  found  in  the  United 
States,  593  are  found  in  New  England,  New  York,  and  New 
Jersey;  and  over  one-half,  or  334,  are  found  in  the  two  States 
of  New  York  and  Massachusetts.  Maine,  Vermont,  Connecti- 
cut and  New  Hampshire  have  215,  the  total  of  which  accounts 
for  all  but  100  of  the  mutual  savings  banks  in  this  country. 

The  dearth  of  savings  banks  in  Pennsylvania  is  notable.  It 
would  seem  strange  that  in  a  state  of  such  character,  where 
the  mutual  savings  bank  had  its  first  test,  and  where  in  indi- 
vidual instances  it  has  been  extremely  popular  and  successful, 
the  failure  of  such  an  institution  has  been  so  pronounced ;  but 
Pennsylvania  is  the  home  of  the  building  and  loan  association 
(there  are  over  1,400  in  operation),  which  seems  in  a  measure 
at  least,  to  fulfill  the  same  purpose.  From  a  pamphlet  issued 
by  the  Dollar  Savings  Bank  of  Pittsburgh  in  1905,  the  striking 
sentence  is  gathered,  that  to-day  at  the  end  of  half  a  century 
the  Dollar  Savings  Bank  stands  as  the  only  institution  of  its 
kind  in  Western  Pennsylvania. 

As  we  go  squth  and  west  the  banks  take  on  a  more  com- 
mercial aspect,  and  the  savings  bank  as  we  know  it  in  the  East 
is  a  rarity,  and  the  word  "  savings  "  in  their  title  is  a  misnomer. 
This  is  particularly  true  of  Iowa,  where  we  find  practically  all 
state  banks  using  this  word,  and  yet  very  few  of  them  are 
other  than  banks  of  discount.  The  reason  for  the  large  num- 
ber may  be  in  the  economic  conditions  of  that  State,  and  also 
the  fact  that  banks  may  organise  with  as  low  as  $10,000  in 


278  SAVINGS  BANKS 

capital,  making  it  possible  to  establish  a  bank  in  even  the  small- 
est place. 

In  Illinois,  for  instance,  we  find  no  distinctively  savings 
banks,  and  in  a  city  like  Chicago,  where  if  the  same  success 
had  attended  the  savings  banks  as  it  has  in  New  York,  upwards 
of  a  billion  dollars  would  be  on  deposit,  we  find  no  strictly 
savings  institution  other  than  banks  of  discount  and  trust  com- 
panies operating  savings  departments. 

The  reasons  for  the  absence  of  mutual  savings  banks  in  the 
West  and  South  lie,  no  doubt,  as  Hamilton  suggests,  in  the 
fact  that  these  sections  were  not  settled  from  religious,  but 
commercial  motives ;  and  the  "  spirit  of  New  England  "  being 
lacking,  the  savings  bank  which  requires  a  peculiar  spirit  of 
philanthropy,  and  age,  as  well,  has  not  become  a  factor  in  the 
development  of  the  country.  In  fact,  the  eleemosynary  insti- 
tution, such  as  the  college,  the  hospital,  or  the  savings  bank, 
the  former  requiring  endowments  of  money  to  become  success- 
ful, and  the  latter  the  endowment  of  gratuitous  management 
to  become  possible,  is  last  to  follow  in  the  economic  develop- 
ment of  a  community.  Another  reason  may  be  in  the  pre- 
ponderance of  agriculture  among  the  employments,  which  does 
not,  until  the  country  becomes  highly  prosperous,  afford  much 
in  the  way  of  idle  funds  which  would  go  into  the  savings 
banks.  The  mutual  savings  bank  is  a  product  of  the  East  and 
promises  to  remain  so  in  spite  of  the  fact  that  some  of  the 
Western  states  have  very  good,  if  not  excellent,  savings  banks 
laws. 

The  dearth  of  savings  banks  in  the  South  is,  no  doubt,  due 
to  the  prostration  following  the  Civil  War,  which  left  the  coun- 
try drained  of  its  resources;  the  general  ignorance  of  banking 
functions,  and  the  improvidence  of  the  Negro. 

POSTAL  SAVINGS  BANKS 

The  postal  savings  bank  is  not  a  bank,  or  a  banking  system, 
so  much  as  it  is  an  adjunct  of  the  Government;  for  the  funda- 
mental idea  is  that  through  the  post  office  the  Government 
holds  itself  out  as  willing  to  accept  the  savings  deposits  of  the 
people,  invest  them  in  its  own  securities  and  become  absolutely 


POSTAL  SAVINGS  BANKS  279 

responsible  for  the  safe  return  of  the  funds  when  called  for, 
with  a  nominal  rate  of  interest.  All  the  leading  countries  of 
the  world  except  Germany  and  Switzerland  now  operate  the 
postal  savings  banks.  While  the  rules  may  differ  in  the  de- 
tails, the  general  scheme  is  the  same,  and  a  review  in  brief  of 
the  system  of  Great  Britain  will  serve  to  illustrate  the  methods 
of  operation  of  such  an  institution. 

The  present  system  was  established  in  England  in  1861. 
The  deposits,  at  whatever  office  they  may  be  made,  can  be 
withdrawn  from  any  other  office  which  transacts  a  savings 
bank  business.  The  accounts  are  kept  in  London  and  all 
moneys  are  remitted  to  the  headquarters,  where  it  is  handed 
over  to  the  Commissioners  for  the  Reduction  of  the  National 
Debt,  who  invest  the  funds  in  public,  securities. 

Deposits  may  be  made  as  low  as  one  shilling  or  multiples 
thereof,  and  the  limit  of  deposits  for  an  individual  is  $150 
during  one  year  or  $650  in  all.  Charitable  societies  may  de- 
posit without  limit.  For  the  benefit  of  youthful  depositors, 
who  have  not  a  shilling  to  deposit,  cards  are  issued  upon  which 
stamps  are  placed  as  purchased,  and  when  filled  represent  one 
shilling,  and  may  be  turned  in  as  cash.  School  managers  are 
urged  to  bring  this  plan  to  the  attention  of  the  pupils,  and  it 
has  been  productive  of  good  results,  over  5,000  schools  having 
adopted  this  system.  The  interest  rate  is  fixed  at  2.l/z  per  cent, 
and  never  varies. 

AMERICAN  POSTAL  SAVINGS  BANKS 

ARGUMENTS  FOR  AND  AGAINST  THE  ESTABLISHMENT  OF 
POSTAL  SAVINGS  BANKS  IN  THE  UNITED  STATES. 

1  In  spite  of  the  numerous  differences  in  the  postal  savings 
bank  system  of  the  forty-odd  countries  possessing  them,  there 
are  certain  fundamental  features  common  to  all.  Whatever 
else  a  postal  savings  bank  may  be,  it  is  without  exception  an 
institution  working  principally  through  the  post  offices,  and  its 
primary  object  is  the  encouragement  of  thrift  among  the 
poorer  classes  by  providing  safe  and  convenient  places  for  the 
deposit  of  savings  at  a  comparatively  low  rate  of  interest.  In 

1  E.  W.  Kemmerer,  The  United  States  Postal  Savings  Bank,  Political 
Science  Quarterly,  Vol.  XXVI,  No.  3,  September,  1911,  pp.  465-77. 


280  SAVINGS  BANKS 

the  discusison  of  the  postal  savings  bank  proposition  in  this 
country,  no  one  questioned  the  desirability  of  encouraging 
habits  of  economy  and  thrift  on  the  part  of  the  public,  nor 
was  there  any  question  'that  adequate  savings  bank  facilities 
should  be  provided  for  this  purpose;  the  debate  hinged  very 
largely  upon  the  question  whether  adequate  facilities  of  this 
character  were  not  already  provided  by  private  initiative. 

The  advocates  of  a  postal  savings  bank  claimed  that  ade- 
quate savings  facilities  were  not  and  could  not  be  provided 
by  private  enterprise,  because  of  the  expense  of  conducting 
savings  banks  in  small  communities,  and  also  in  larger  com- 
munities where  the  people  were  not  yet  educated  to  the  saving 
habit;  and  they  pointed  particularly  to  the  lack  of  savings 
facilities  in  the  southern  and  western  states.  .  .  . 

.  .  .  The  country  is  not  nearly  so  well  .provided  with 
banks  receiving  savings  accounts  as  with  post  offices.  In  the 
United  States  there  are  270  square  miles  of  territory  to  each 
bank  carrying  savings  accounts  and  50  square  miles  to  each 
post  office ;  there  is  a  population  of  8,370  to  each  such  bank  and 
of  1,542  to  each  post  office;  and  there  are  5.4  post  offices  to 
each  bank  carrying  savings  accounts.  A  comparison  of  the 
figures  for  the  different  sections  and  states  shows  that  it  is  in 
the  -southern,  western,  and  Pacific  states  that  savings  bank 
facilities  are  most  lacking.  .  .  .  The  New  England,  eastern, 
and  middle  western  states  are  much  better  provided  with 
banking  facilities  than  are  the  other  sections ;  but  even  in  these 
states  post  office  facilities  are  much  more  ample  than  savings 
bank  facilities.  .  .  . 

An  objection  repeatedly  urged  against  the  establishment  of 
a  postal  savings  bank  was  that  it  would  prove  a  competitor  to 
existing  banks.  The  fear  of  such  competition  appears  to  have 
been  the  chief  cause  of  the  opposition  of  most  members  of  the 
banking  fraternity  to  all  postal  savings  banks  proposals.  Sen- 
ator Cummins  of  Iowa  said  in  the  Senate : 

The  banks  of  the  United  States  are  opposed  unanimously  to  the 
institution  of  a  postal  savings  system.  ...  I  venture  the  assertion 
that  during  the  nearly  two  years  that  I  have  been  a  member  of  this 
body  ...  I  have  received  the  protests  of  nearly  every  bank  in  my 
state  against  any  such  scheme,  and  those  protests  have  usually  been 


,      POSTAL  SAVINGS  BANKS  281 

accompanied  by  a  very  large  number  of  petitions,  secured,  I  have 
no  doubt,  through  the  industry  and  energy  of  the  bank  officers. 

It  was  argued  that  postal  savings  banks  would  have  an  un- 
due advantage  over  private  institutions  because  of  the  great 
confidence  in  the  Government  entertained  by  working  people; 
and  it  was  asserted  that  funds  would  be  withdrawn  from  exist- 
ing banks  and  deposited  in  the  postal  savings  banks.  ...  In 
reply,  the  advocates  of  postal  savings  banks  claimed  that  exist- 
ing banks  had  nothing  to  fear  from  governmental  competition  ; 
that  they  had  the  advantages  of  an  established  clientele,  higher 
interest  rates,  higher  limits,  if  any,  in  the  amounts  that  could 
be  kept  on  deposit,  and  of  the  close  personal  and  advisory  rela- 
tion which  so  often  exists  between  a  bank  and  its  customers. 
They  further  argued  that  postal  savings  banks  would  be  a 
help  rather  than  a  hindrance  to  other  banks.  They  would  edu- 
cate the  people  to  habits  of  thrift  and  would  draw  money  out 
of  hoards;  and  the  deposits  which  they  received  would  for  the 
most  part  be  transferred  to  other  banks  as  soon  as  the  limit 
fixed  for  postal  savings  banks  deposits  should  be  reached,  or 
even  before,  as  the  depositor  began  to  appreciate  the  safety  of 
other  banks  and  the  advantage  of  their  higher  rate  of  inter- 
est. .  .  . 

The  immediate  occasion  of  the  last  active  movement  for  a 
postal  savings  bank  system  in  the  United  States  was  .  .  .  the 
losses  and  inconveniences  arising  from  bank  failures  and  from 
the  suspension  of  cash  payments  in  the  panic  of  1907.  Natu- 
rally, therefore,  the  demand  for  great  safety  of  savings  de- 
posits played  an  important  part  in  the  discussion. 

The  advocates  of  postal  savings  banks  cited  figures  showing 
the  number  of  national  bank  failures  and  the  losses  involved, 
and  similar  figures  for  savings  bank  failures  in  certain  states. 
They  made  much  of  the  large  amounts  involved  and  of  the 
hardships  in  individual  cases.  On  the  other  hand,  the  oppo- 
nents of  the  postal  savings  bank  scheme  quite  generally  dealt 
with  percentage  figures  rather  than  with  absolute  amounts  and 
showed  that  for  recent  years  the  average  losses,  in  terms  of 
percentage  of  the  amounts  on  deposit,  were  almost  infinitesi- 
mal. 

The  figures  cited  for  bank  failures,  so  far  as  they  relate  to 


282  SAVINGS  BANKS 

savings  deposits,  are  so  incomplete  as  to  be  of  doubtful  value 
in  measuring  the  extent  of  the  losses.  .  .  . 

After  all,  such  figures  give  us  no  adequate  measure  for 
losses  of  this  kind.  "  Among  the  experiences  of  working 
people  none  is  more  demoralizing  and  few  are  more  cruel  than 
loss  of  savings  through  failure  of  banks  or  absconding  of  indi- 
viduals intrusted  with  funds."  To  such  people  there  is  cold 
comfort  in  the  assurance  that  the  average  loss  of  savings  bank 
depositors  over  a  long  period  of  years  is  but  a  fraction  of  a 
mill  on  a  dollar.  The  loss  is  theirs :  it  is  not  distributed  among 
all  depositors. 

In  urging  that  a  postal  savings  bank  would  draw  money 
from  hoards  into  circulation,  the  advocates  of  the  scheme 
claimed  also  that  such  a  bank  would  keep  in  the  United  States 
money  that  would  otherwise  be  sent  abroad  by  foreigners.  .  .  . 
Much  was  made  of  the  fact  that  every  year  many  millions  of 
dollars  in  money  orders  payable  to  self  are  bought  for  savings 
purposes.  ...  In  such  cases  the  purchaser  not  only  failed  to 
receive  any  interest  on  his  savings  but  was  required  to  pay  the 
money  order  fee.  Many  immigrants,  moreover,  distrust 
American  banks,  and,  being  familiar  with  postal  savings  banks 
in  their  home  countries  and  having  great  confidence  in  gov- 
ernment institutions,  remit  their  savings  to  these  home  banks. 
How  extensively  this  is  done  we  have  no  figures  to  show.  .  .  . 

THE   MAIN   FEATURES   OF   THE   SYSTEM 

1  The  Postal  Savings  Bank  System  of  the  United  States, 
which  began  operations  January  3,  1911,  by  the  opening  of  a 
postal  savings  bank  in  each  state,  is  under  the  control  of  a 
board  of  trustees,  consisting  of  the  Postmaster-General,  the 
Secretary  of  the  Treasury,  and  the  Attorney-General. 

Depositories  for  the  receipt  of  such  moneys  are  designated 
by  the  Board.  An  initial  appropriation  of  $100,000  was  made 
to  cover  the  cost  of  putting  the  law  in  operation,  which  was 
supplemented  by  another  appropriation  of  $500,000  in  the  ses- 
sion of  1911. 

Any  person  over  ten  years  of  age  may  deposit,  but  no  per- 

1  W.  H.  Kniffin.  The  Savings  Bank  and  Its  Practical  Work,  pp.  75,  7°. 
The  Bankers  Publishing  Company,  New  York.  1912. 


POSTAL  SAVINGS  BANKS  283 

son  shall  have  more  than  one  postal  savings  bank  account  in 
his  or  her  own  right.  Upon  making  the  first  deposit,  a  certifi- 
cate of  deposit  is  issued,  which  is  to  be  surrendered  when  paid, 
and  cancelled ;  or  in  the  event  of  making  a  subsequent  deposit 
is  to  be  surrendered  for  one  calling  for  a  higher  amount.  The 
lowest  deposit  permitted  is  one  dollar,  the  limit  being  $100  in 
a  calendar  month;  but  to  provide  for  small  deposits,  a  postal 
savings  card  is  issued  for  ten  cents,  to  which  may  be  attached 
postal  savings  stamps,  which  when  filled  will  be  accepted  in 
lieu  of  one  dollar. 

The  interest  rate  allowed  is  2  per  cent.,  credited  once  a  year, 
and  the  highest  balance  permitted  is  $500  to  one  person. 
Withdrawals  may  be  made  on  demand. 

The  funds  so  received  are  to  be  deposited  in  national  and 
state  banks  at  2j4  per  cent,  interest.  Five  per  cent,  of  these 
deposits  may  be  withdrawn  and  kept  in  the  Treasury  of  the 
United  States  as  reserve.  Before  becoming  a  depository,  the 
bank  must  furnish  as  security  government,  state,  or  municipal 
bonds,  the  limit  of  deposits  being  an  amount  equal  to  the 
paid-up  capital  and  one-half  the  surplus.  .  .  .  Not  over  30 
per  cent,  of  the  amount  of  such  funds  may  be  withdrawn  by 
the  trustees  for  investment  in  United  States  bonds,  and  it  is 
the  intent  of  the  act  that  the  residue  of  such  funds  amounting 
to  65  per  cent.,  shall  remain  on  deposit  in  the  banks  in  each 
state  and  territory  willing  to  receive  the  same  under  the  terms 
of  the  act,  but  may  be  withdrawn  for  investment  in  bonds 
under  the  direction  of  the  President,  "  when  in  his  judgment, 
the  general  welfare  and  interests  of  the  United  States  so  re- 
quire." Provision  is  also  made  for  the  conversion  of  savings 
bank  deposits  into  United  States  bonds,  at  the  request  of  de- 
positors. 

"  POSTAL  SAVINGS  BEHIND    THE  SCENES  " 

Speech  of  Hon.  Carter  B.  Keene,  Director  of  the  United  States  Postal 
Savings  System  at  the  Banquet  of  the  Investment  Bankers  Association 
of  America  at  Denver,  Colorado,  Tuesday  evening,  September  21,  1915. 

Mr.  Toastmaster  and  Gentlemen: 

I  appreciate  very  highly  your  invitation  to  speak  here  to- 
night, also  the  words  of  commendation  from  your  presiding 


284  SAVINGS  BANKS 

officer.  I  have  often  wondered  whether  the  fact  that  I  am 
the  only  director  of  a  big  savings  institution  has  anything  to 
do  with  the  ability  of  that  institution  to  pay  every  depositor 
his  money  on  demand.  (Laughter  and  applause.)  .  .  . 

The  toastmaster  was  wrong  when  he  said  that  postal  sav- 
ings has  nothing  to  do  with  investment  bankers.  We  have  a 
great  deal  to  do  with  them.  Indirectly,  we  are  one  of  their 
best  customers.  More  than  ninety-four  million  dollars  in 
bonds  are  now  with  the  Treasurer  of  the  United  States  as 
security  for  postal  savings  funds,  and  you  gentlemen  have 
largely  supplied  the  banks  with  these  bonds.  Sixteen  million 
dollars  are  in  State  and  Territory  bonds;  city,  town,  and  vil- 
lage bonds  amount  to  forty-six  millions;  county  bonds  nine; 
miscellaneous  bonds  ten ;  and  bonds  of  the  United  States  Gov- 
ernment and  its  dependencies  thirteen.  .... 

Since  I  have  been  here  this  week  I  have  heard  billions  and 
billions  talked  about.  ...  I  can  hardly  comprehend  what  a 
million  is.  But  I  want  to  tell  you  that  in  four  and  a  half  years 
the  postal  savings  system  of  the  United  States  has  become  cus- 
todian of  sixty-eight  million  dollars,  in  cash,  of  the  people's 
savings.  Let  me  lay  emphasis  on  the  cash,  because  big  figures 
do  not  always  mean  cash.  Sixty-five  million  dollars  of  this 
money  is  on  deposit  in  six  thousand  banks  scattered  through- 
out the  country.  In  other  words,  practically  all  of  the  money 
we  have  collected  has  been  released  through  the  banks  to  chan- 
nels of  trade  in  the  very  localities  where  it  originated.  I  am 
sure  you  will  agree  with  me  that  this  is  a  very  creditable  show- 
ing so  far  as  dollars  and  cents  are  concerned. 

The  Federal  Reserve  Act,  which  went  into  effect  on  the  i6th 
of  November  last,  provided  that  postal  savings  funds  should 
not  be  deposited  in  non-member  banks.  The  Attorney  Gen- 
eral for  the  United  States  has  held  that  the  prohibition  relates 
to  funds  received  on  and  after  November  i6th.  Therefore, 
postal  savings  on  deposit  in  state  institutions  when  the  act  be- 
came effective  have  been  allowed  to  remain,  except  as  it  has 
been  necessary  to  withdraw  it  to  pay  depositors. 

The  Post  Office  Department  has  made  frequent  investiga- 
tions to  determine  where  postal  savings  deposits  come  from; 
with  the  invariable  result  that  they  are  found  to  come  from 


POSTAL  SAVINGS  BANKS  285 

chimney  corners,  mattresses,  bootlegs,  etc.,  but  until  very  re- 
cently no  effort  has  been  made  to  ascertain  where  postal  sav- 
ings go  when  withdrawn.  And  this  recent  inquiry  has  been 
both  gratifying  and  entertaining.  It  was  found  that  in  a  vast 
majority  of  cases  savings  were  withdrawn  for  very  substantial 
reasons,  prominent  among  them  being  payments  on  homes  and 
the  launching  of  small  business  enterprises.  Occasionally  a 
hospital  bill  was  paid.  Some  depositors  sent  money  to  the 
old  country  to  bring  over  a  parent  or  a  brother;  a  wedding 
trousseau  here  and  there ;  and  in  Colorado  we  have  record  of  a 
withdrawal  to  buy  an  automobile.  (Laughter.) 

I  am  glad  to  say  that  there  has  been  a  very  great  change  in 
the  attitude  of  the  banks  toward  postal  savings  in  the  last  few 
years.  At  the  outset,  many  bankers  thought  that  postal  sav- 
ings was  an  unwarranted  invasion  of  the  domain  of  private 
enterprise  and  that  the  service  would  prove  a  severe  drain  on 
their  established  business.  The  opposite  has  been  the  result. 
The  tarnished  coins  and  soiled  currency  that  come  into  our 
postal  depositories  represent  hidden  savings  —  money  that  is 
beyond  the  reach  of  any  corporate  banking  institution  no  mat- 
ter how  sound  it  may  be  or  how  conservatively  managed. 
This  newly  discovered  money  has  been  made  available  for 
commercial  purposes  in  the  very  cities  and  localities  from 
which  it  was  withdrawn,  so  instead  of  being  a  drain  on  cor- 
porate banking  institutions  postal  savings  has  added  to  the 
deposits  of  some  six  thousand  banks  more  than  sixty-five  mil- 
lions. The  bankers  now  freely  admit  that  postal  savings  has 
been  a  help  to  them,  and  it  is  no  uncommon  thing  for  banks, 
especially  in  the  mining  regions  of  the  West,  to  urge  the  Post 
Office  Department  to  extend  postal  savings  facilities  in  order 
that  more  money  may  be  made  available  for  local  uses. 

Among  our  540,000  depositors  every  nation  on  the  face  of 
the  earth  is  represented,  also  every  conceivable  occupation. 
The  fisherman,  the  miner,  the  shoemaker,  the  preacher,  the 
bank  teller,  the  butcher,  the  baker,  the  candle-stick  maker,  all 
have  accounts,  but  the  great  bulk  of  our  deposits  come  from 
the  men  and  women  who  work  with  their  hands  for  a  daily 
wage. 

The  foreign  born  are  our  most  numerous  and  liberal  pa- 


286  SAVINGS  BANKS 

trons.  An  interesting  poll  of  depositors  has  just  been  made 
by  the  Post  Office  Department  and  it  was  found  that  59  per 
cent,  of  all  postal  savings  depositors  were  born  outside  the 
United  States,  while  the  American  born  comprise  41  per  cent. 
A  still  more  surprising  fact  is  that  the  foreign  born  own  72 
per  cent,  of  all  the  deposits.  The  Russians  lead  with  $14,- 
000,000  to  their  credit,  or  20.7  per  cent.  Then  follow  the 
Italians  with  $9,650,000,  or  14.2  per  cent.;  natives  of  Great 
Britain  and  her  colonies  with  $6,000,000,  or  8.8  per  cent. ;  the 
Austrians  with  $5,900,000,  or  8.7  per  cent. ;  Hungarians,  $2,- 
900,000,  or  4.3  per  cent.;  Germans,  $2,800,000,  or  4.1  per 
cent;  Swedes,  $1,500,000,  or  2.2  per  cent.;  and  Greeks, 
$1,200,000,  or  1.8  per  cent 

What  a  splendid  vote  of  confidence  on  the  part  of  our  for- 
eign-born citizens  in  the  good  faith  of  the  United  States.  And 
in  these  figures  also  is  a  high  testimonial  to  the  industry  and 
frugality  of  our  newly  acquired  citizens.  That  they  should 
take  most  kindly  to  postal  savings  is  not  remarkable  when  we 
consider  that  they  were  accustomed  to  a  similar  service  in 
their  native  countries.  .  .  . 

Another  thing  that  has  induced  foreigners  to  become  postal 
savings  depositors  is  the  disastrous  experiences  many  of  them 
have  had  with  so-called  "  private  banks,"  usually  operated  by 
people  of  their  own  tongue.  It  is  difficult  to  conceive  of  a 
more  heinous  crime  than  some  of  these  so-called  "  bankers  " 
—  slick  and  persuasive  —  have  committed  in  alluring  credu- 
lous, hard-\vorking  men  and  women,  to  entrust  their  humble 
savings  with  them  for  the  deliberate  purpose  of  theft.  I  am 
glad  to  see  that  prosecuting  officers  have  recently  been  aroused 
to  the  "  private  bank  swindle  "  and  that  their  promoters  are 
getting  the  punishment  they  deserve. 

When  Europe  got  on  fire  last  year,  our  postal  savings  re- 
ceipts began  to  increase  by  leaps  and  bounds.  During  the 
fiscal  year  1915,  the  deposits  jumped  from  $43,440,000  to 
$65,680,000  and  more  than  140,000  new  accounts  were  opened. 
The  war  still  has  an  influence  upon  postal  savings  deposits,  but 
the  more  immediate  cause  of  large  deposits  at  this  time  is  the 
remarkable  revival  of  commercial  activities.  Seven  cities  now 
have  more  than  a  million  dollars  on  deposit,  namely,  New 


POSTAL  SAVINGS  BANKS  287 

York,  Brooklyn,  Chicago,  Boston,  Detroit,  San  Francisco,  and 
Portland,  Oregon.  Greater  New  York,  including  Brooklyn 
and  several  other  offices  in  the  municipality,  now  have  over 
one-fourth  of  all  the  money  in  the  Postal  Savings  System. 
During  the  past  fiscal  year  New  York  City  gained  200  per 
cent.;  Bridgeport,  Connecticut,  188  per  cent.;  Brooklyn,  New 
York,  167  per  cent. ;  Paterson,  New  Jersey,  162  per  cent. ;  Jer- 
sey City,  New  Jersey,  122  per  cent;  Detroit,  Michigan,  112 
per  cent. ;  Newark,  New  Jersey,  100  per  cent. ;  Akron,  Ohio, 
77  per  cent. ;  Gary,  Indiana,  66  per  cent. ;  Pueblo,  Colorado,  52 
per  cent. 

Now,  my  friends,  I  come  to  a  point  that  I  hope  will  make 
an  impression  on  your  minds  —  a  lasting  impression  —  and 
that  point  is  that  the  Postal  Savings  System  from  the  first 
has  been  seriously  handicapped  by  statutory  restrictions  on 
the  amount  that  may  be  accepted.  The  law  permits  the  ac- 
ceptance of  only  one  hundred  dollars  a  month  and  five  hun- 
dred dollars  in  all  from  a  depositor.  It  has  been  shown  that 
the  foreign  born  are  the  largest  patrons  of  our  savings  service 
and  if  this  service  is  to  reach  its  full  measure  of  success  we 
must  recognize  and  respect  the  habits  of  the  foreigner,  and 
one  of  his  habits  is  to  save  his  money  until  he  gets  several  hun- 
dred dollars  together  and  then  take  the  entire  amount  to  the 
post  office,  just  as  he  did  in  the  old  country.  Because  the  post- 
master cannot  accept  all  that  is  offered,  the  intending  depositor 
very  frequently  goes  away  in  resentment  and  disappointment 
without  depositing  a  dollar.  .  .  . 

It  is  the  testimony  of  postmasters  from  all  over  the  country 
that  they  are  rejecting  about  as  much  money  as  they  are  taking 
in.  The  Postmaster  General  last  year  recommended  to  Con- 
gress that  one  thousand  dollars  be  accepted  with  interest  and 
that  another  thousand  dollars  be  accepted  without  interest,  but 
for  safe-keeping.  That  was  a  practical  and  reasonable  recom- 
mendation —  one  which  would  meet  all  requirements  in  ninety- 
five  per  cent,  of  the  cases.  Unfortunately  the  recommenda- 
tion failed.  .  .  .  The  Postmaster  General  has  indicated  that 
he  will  repeat  the  recommendation  in  his  forthcoming  annual 
report  and  I  sincerely  hope  that  Congress  will  promptly  recog- 
nize the  urgent  need  of  the  legislation.  Millions  of  dollars, 


288  SAVINGS  BANKS 

my  friends,  are  spent  every  year  by  uplift  societies  for  the  bet- 
terment of  the  foreigners.  These  foreigners,  these  begrimed, 
hard-working  foreigners,  come  to  our  post  offices  and  ask  us 
to  take  their  humble  savings.  How  unfortunate  that  we  can- 
not accept  what  they  offer,  within  reasonable  bounds.  What 
an  effective  agency  this  would  be  in  bettering  in  a  most  prac- 
tical and  permanent  way  the  conditions  of  the  very  people  we 
want  to  Americanize  as  speedily  as  possible. 

.  .  .  We  have  five  hundred  and  forty  thousand  depositors 
in  the  United  States  to-day  and  postal  savings  has  a  new  and 
different  story  for  each  of  .them.  It  is  not  always  the  big 
things  in  life  that  change  or  fix  our  course.  Can't  you  remem- 
ber when  a  few  dollars  or  the  want  of  a  few  dollars  tipped  you 
one  way  or  the  other  in  some  important  matter.  Who  can 
estimate  the  happiness  and  prosperity  that  the  starting  of  a 
postal  savings  account  may  lead  to.  It  is  a  step,  and  an  im- 
portant one,  in  the  right  direction.  Some  one  has  well  said 
that  the  immigrant  who  opens  a  postal  savings  account  steps 
unconsciously  on  a  moving  platform;  one  thing  leads  to  an- 
other, and  his  deposit  might  lead  him  into  local  investment  and 
investment  into  business  and  into  citizenship. 

There  is  a  very  interesting  human-interest  side  to  postal  sav- 
ings in  which  every  phase  of  good  fortune  and  disaster  is  re- 
flected. An  aged  couple  at  Norfolk  without  the  knowledge 
of  each  other  had  been  carrying  $100  on  their  persons  as  a 
guaranty  of  respectable  burial.  They  are  now  postal  savings 
depositors.  Two  sisters  died  in  each  other's  arms  in  the  East- 
land  disaster  in  Chicago  a  few  weeks  ago  —  two  working  girls 
—  and  they  had  postal  savings  accounts  for  like  amounts. 
Their  savings  went  to  pay  for  their  burial.  One  of  Uncle 
Sam's  bluejackets  who  went  down  on  the  ill-fated  submarine 
F-4  was  the  owner  of  a  substantial  postal  savings  account. 
Gentlemen,  the  Postal  Savings  System  means  something 
more  than  a  cold  array  of  assets  and  liabilities,  a  balance  sheet. 
Way  off  in  an  isolated  spot  in  Russia  a  money  order  went  not 
long  ago  to  the  home  of  a  humble  peasant.  That  money  order 
represented  the  savings  of  a  son  who  was  drowned  in  the  Sus- 
quehanna  River.  A  few  weeks  back,  a  thrifty  Mexican  girl 
withdrew  her  savings  from  the  post  office  at  San  Diego,  Cali- 


POSTAL  SAVINGS  BANKS  289 

fornia,  to  buy  a  trousseau.  After  the  honeymoon  she  returned 
to  the  office  with  her  new  husband  and  both  opened  postal  sav- 
ings accounts. 

Last  year  Leadville,  Colorado,  struck  a  thrift  note  that  was 
new  in  this  country,  so  far  as  I  know,  and  reference  to  it  is 
particularly  timely  as  Christmas  is  approaching.  A  mining 
company  in  that  city  struck  the  note  and  I  hope  it  will  be 
heard  from  one  end  of  this  country  to  the  other.  It  was  this : 
Last  December  an  officer  of  the  company  went  to  the  post  office 
and  opened  a  postal  savings  account  for  every  employee — • 
ninety  in  all  —  as  a  Christmas  present.  He  placed  to  the 
credit  of  each  2  per  cent,  of  what  he  had  earned  during  the 
year.  These  Christmas  remembrances  amounted  to  over  fif- 
teen hundred  dollars.  Out  of  the  ninety  employees  only  five 
had  previously  opened  postal  savings  accounts.  Now,  I  count 
that  substantial  charity ;  I  call  that  well-directed  charity.  We 
have  kept  track  of  these  particular  deposits  and  the  workmen 
who  get  their  start  through  that  Christmas  bounty  are  adding 
to  their  savings  weekly  by  their  own  personal  efforts.  (Ap- 
plause. ) 

Gentlemen,  as  a  rule,  we  in  official  life  swing  back  and  forth 
in  a  measured  arc,  and  the  little  one  can  do  is  so  small  when 
compared  with  the  mass  of  Government  activity  that  we  feel 
insignificant  and  lost.  But  I  feel,  my  friends,  that  in  the 
Postal  Savings  System  my  associates  and  I  are  doing  a  posi- 
tive good  for  humanity.  I  believe  that  we  are  making  people 
better  and  happier  because  postal  savings  points  the  way  from 
the  sweat  shop  to  the  school  —  it  stands  for  clean  homes  and 
empty  alleys.  Each  of  you  is  a  stockholder  in  the  Postal  Sav- 
ings System  and  its  success  is  your  success.  Your  dividends 
are  in  the  better  and  happier  American  citizenship  which  it 
encourages  and  promotes.  (Applause.) 


CHAPTER  XVII 
DOMESTIC  EXCHANGE 

1  THE  banker  has  become  the  bookkeeper  and  settling  agent 
of  the  business  world.  The  products  of  a  locality,  let  us  say 
the  State  of  Georgia,  move  out  to  the  markets  of  the  world 
and  create  credits  in  favor  of  that  locality  on  the  books  of 
banking  institutions  in  the  commercial  centers,  while  at  the 
same  time  a  counter  movement  of  commodities  is  under  way 
from  other  localities  into  Georgia,  in  like  manner  creating 
credits  for  those  localities  which  are  debits  against  Georgia. 
The  practical  effect  is  that  the  commodities  moving  between 
these  communities  are  exchanged  and  pay  for  themselves,  the 
running  accounts  being  kept  and  settlements  effected  in  the 
banks. 

To  illustrate  the  details:  A  dealer  in  cotton  in  Atlanta 
makes  a  sale  to  a  mill  in  Fall  River  and  receives  in  payment  a 
check  or  draft  drawn  on  a  New  York  bank,  which  he  deposits 
for  the  credit  of  his  account  in  an  Atlanta  bank,  and  which 
the  latter  forwards  for  the  credit  of  its  bank  account  in  New 
York.  Meanwhile  an  Atlanta  merchant  has  bought  goods  in 
New  York  and  in  order  to  pay  for  them  buys  from  the  Atlanta 
bank  an  order  for  the  New  York  credit,  and  this  when  for- 
warded completes  the  circle  of  payments  for  cotton  and  goods. 

If  we  would  extend  the  investigation  to  include  the  bank 
accounts  of  the  Fall  River  mill  and  the  Atlanta  dealer  we 
would  find,  first,  that  the  mill  account  was  built  up  constantly 
by  deposits  of  checks  and  drafts  received  in  payment  for 
goods  sold  in  all  parts  of  the  country  and  perhaps  all  over  the 
world,  with  almost  no  deposits  of  casjh,  and  that  it  was  drawn 
down  by  checks  for  raw  cotton,  and  supplies  and  large 
amounts  of  cash  for  the  pay-rolls ;  second,  that  the  cotton  deal- 

1  Frank  A.  Vanderlip,  Modern  Banking,  Three  Addresses  delivered  at 
Chautauqua,  New  York,  August,  1911,  pp.  17-29.  The  National  City  Bank. 
New  York.  1911  [?]. 

290 


BANKS  AS  EQUALIZING  AGENCIES  291 

er's  account  was  built  up  entirely  by  deposits  of  checks  or 
drafts  received  for  cotton  shipments  and  drawn  down  by 
checks  and  cash  payments  to  farmers  for  cotton. 

For  payments  at  a  distance  bank  credit  in  the  form  of  a 
check  or  draft  is  [commonly]  used.  .  .  . 

The  foregoing  illustrates  the  movement  of  the  exchanges 
constantly  proceeding  .  .  .  between  .  .  .  different  communi- 
ties. .  .  .  There  is  a  network  of  relationship  between  banks 
through  which  each  local  community  and  market  is  connected 
with  all  other  communities  and  markets.  .  .  .  No  locality  is 
so  remote  as  to  be  outside  of  the  circle  and  no  community's 
sales  and  purchases  are  so  scattered  but  that  they  can  be 
brought  together  in  the  settlements.  Each  bank  is  the  center 
of  a  circle  of  which  it  is  the  clearing  agent;  all  payments  be- 
tween its  own  customers  may  be  made  by  a  transfer  of  credit 
upon  its  books.  If  there  are  two  banks  or  more  banks  in  a 
town,  all  payments  between  their  customers  are  resolved  into 
offsets  between  these  banks,  and  in  like  manner  all  payments 
between  localities  are  resolved  into  offsets  between  banks,  and 
if  not  settled  in  local  centers  are  passed  up  to  larger  and  larger 
clearing  centers.  .  .  . 

But  while  the  cross-payments  of  trade  may  be  depended 
upon  in  the  long  run  to  balance  and  settle  themselves,  it  does 
not  follow  that  they  will  do  so  from  day  to  day,  or  that  they 
coincide  so  closely  that  payments  in  money  are  never  required. 
An  individual's  sales  and  purchases  are  seldom  made  at  the 
same  time,  and  the  sales  and  purchases  of  communities  are 
not  constantly  balanced.  The  trade  of  a  one-crop  farming 
district  will  not  be  so  evenly  balanced  as  one  of  a  district  in 
which  mixed  farming  prevails,  and  in  every  industry  there  are 
periods,  usually  recurring  every  year,  when  the  payments  ex- 
ceed the  current  income,  and  corresponding  periods  when  in- 
come exceeds  outgo.  .  .  . 

A  region  like  the  cotton  states,  whose  products  move  quickly 
to  market,  may  have  large  credit  balances  at  one  season  and 
at  another  be  wanting  to  borrow.  .  .  . 

The  banker  is  an  equalizing  agency  in  the  situation.  He 
stands  in  the  breach :  he  must  either  supply  the  missing  offsets 
of  credit,  or,  as  a  last  resort,  make  the  payments  in  money.  .  .  . 


292  DOMESTIC  EXCHANGE 

The  entire  system  of  settlements,  with  transfers  and  offsets 
and  advances  and  interchange  of  capital  and  credit,  is  exceed- 
ingly interesting  and  wonderfully  simple  and  effective,  but 
depends  for  its  effectiveness  upon  a  scrupulous  observance  of 
the  principle  upon  which  it  is  based.  That  principle  is  the 
natural  reciprocity  of  trade.  .  .  . 

While  there  are  balances  from  time  to  time  in  the  exchanges 
.  .  .  between  different  localities  .  .  .  which  cannot  be  settled 
without  shipments  of  money,  they  are  usually  met  without  in- 
convenience unless  there  is  a  disturbance  of  credit. 

EXCHANGE  RELATIONS  BETWEEN  CHICAGO  AND  NEW 

YORK 

1.  .  .  It  should  always  be  borne  in  mind  that  the  fact  that 
New  York  City  is  the  country's  dominating  financial  market 
results  in  making  New  York  funds  acceptable  everywhere  as 
a  means  of  payment,  and  in  making  a  ready  market  for  New 
York  exchange  throughout  the  country  for  a  large  part  of 
the  year. 

Throughout  January  money  in  Chicago  relative  to  that  in 
New  York  City  is  cheap.  Exchange  rates  on  New  York  are 
high  and  there  is  a  considerable  movement  of  cash  from  Chi- 
cago to  the  Eastern  States  —  particularly  to  New  York 
City.  .  .  . 

Just  prior  to  January  I  there  is  normally  a  large  demand 
in  Chicago  for  New  York  exchange  with  which  to  meet  divi- 
dend and  interest  payments  due  in  New  York,  and  the  high 
rates  thus  created  continue  somewhat  into  the  new  year.  The 
crop-moving  and  holiday  demand,  however,  being  over,  money 
becomes  relatively  cheap  in  Chicago  and  flows  to  New  York 
City,  where  it  can  at  least  earn  the  2  per  cent  paid  by  banks 
on  bankers'  balances,  and  where  it  is  absorbed  somewhat  in 
speculative  activity  and  in  the  higher  security  prices,  which 
normally  rule  the  latter  part  of  January  and  the  fore  part  of 
February. 

1 E.  W.  Kemmerer,  Seasonal  Variations  in  the  Relative  Demand  for 
Money  and  Capital  in  the  United  States.  Publication  of  the  National 
Monetary  Commission,  Senate  Document  No.  588,  6ist  Congress,  2d  Ses- 
sion, pp.  96-100. 


CHICAGO  AND  NEW  YORK  293 

From  the  last  of  January  to  the  fore  part  of  March  the  de- 
mand for  money  in  Chicago  relative  to  that  in  New  York 
rapidly  rises.  Exchange  rates  on  New  York  fall  to  a  low 
point,  and  shipments  of  cash  to  the  Eastern  States  are  very 
small.  .  .  . 

.  .  .  There  is,  however,  no  evidence  of  a  movement  of  cash 
from  the  East  to  Chicago  in  February,  although  there  is  some- 
thing of  a  westward  movement  in  March. 

During  this  period  the  relative  demand  for  money  in  Chi- 
cago is  increased  by  the  anticipated  opening  of  navigation  on 
the  Great  Lakes,  for  the  opening  of  navigation  gives  rise  to  a 
large  amount  of  New  York  exchange  received  in  payment  of 
grain  bills.  There  is  also  a  demand  on  the  part  of  western 
bankers  for  currency  to  meet  the  spring  needs  of  the  western 
farmers.  The  first  of  March  in  many  sections  of  the  Middle 
West  is  the  commonest  time  for  making  settlements  of  inter- 
est and  principal  on  farm  mortgages.  It  is  also  a  common 
date  for  paying  farm  rents. 

This  spring  advance  in  the  value  of  money  in  Chicago  as 
compared  with  New  York  reaches  its  maximum  early  in 
March.  The  demand  then  falls  off  rapidly  and  with  only 
temporary  interruptions  (the  most  noteworthy  being  about  the 
first  of  May)  until  it  reaches  the  low  level  of  the  early  sum- 
mer, the  latter  part  of  May.  It  continues  at  a  low  level  until 
early  in  July,  when  the  crop-moving  advance  begins.  .  .  . 

About  the  first  of  July  the  relative  demand  for  money  in 
Chicago  and  vicinity  begins  to  increase,  advancing  rapidly, 
with  minor  interruptions,  until  early  in  September,  and  then 
maintaining  a  high  level  until  the  fore  part  of  November. 
During  this  period  exchange  rates  rule  low  and  money  moves 
in  large  quantities  from  the  Eastern  States  to  Chicago.  .  .  . 

The  primary  cause  for  this  increasing  and  large  demand  for 
money  in  Chicago  is  of  course  the  anticipated  and  actual  crop- 
moving  demand,  there  being  no  sufficiently  strong  Eastern  de- 
mand for  money  at  the  time  to  hold  it  back.  .  .  . 

It  has  been  found  .  .  .  that  during  the  last  six  to  eight 
weeks  of  the  year,  after  the  crop-moving  demand  has  to  a  large 
extent  subsided,  the  relative  demand  for  moneyed  capital  in 
both  New  York  City  and  Chicago  is  maintained  until  the  time 


2Q4  DOMESTIC  EXCHANGE 

of  January  settlements  at  nearly  the  high  level  of  the  crop- 
moving  period.  A  study  of  domestic  exchange  rates  and  of 
currency  shipments  shows  that  the  relative  demand  for  money 
is  stronger  during  this  period  in  New  York  City  than  in  Chi- 
cago, that  exchange  rates  in  Chicago  on  New  York  rise,  and 
that  cash  moves  eastward.  .  .  . 

Money  becomes  relatively  cheap  in  Chicago  and  vicinity  dur- 
ing these  last  six  to  eight  weeks  of  the  year,  principally  be- 
cause of  the  return  flow  of  currency  previously  shipped  to  the 
country  districts  for  crop-moving  purposes.  There  is  also 
considerable  demand  at  this  time  for  New  York  exchange  to 
meet  payments  in  certain  lines  of  goods,  such  as  hardware  and 
dry  goods,  that  are  due  New  York  and  New  England  houses 
by  Western  establishments,  and  to  make  purchases  for  the 
holiday  trade.  .  .  .  Comparatively  high  exchange  rates  .  .  . 
[near]  the  end  of  the  year  are  largely  due  to  preparations  for 
the  January  disbursements,  which  Western  concerns  are  called 
upon  to  make  in  New  York  City.  .  .  .* 

EXCHANGE  RELATIONS  BETWEEN  ST.  Louis  AND  NEW 

YORK 

2  ...  General  seasonal  movements  in  the  relative  demand 
for  money  in  St.  Louis  (as  compared  with  New  York  City), 
.  .  .  are  fairly  regular  in  their  occurrence. 

From  the  beginning  of  the  year  until  the  fore  part  of  May 
the  demand  appears  to  be  moderate,  exchange  rates  rule  near 
par,  and  there  is  a  moderate  tendency  for  cash  to  move  from 
St.  Louis  to  the  Eastern  States,  with  almost  no  tendency  to 
move  in  the  opposite  direction.  .  .  . 

The  first  eighteen  weeks  of  the  year,  St.  Louis  bankers  say, 
are  a  period  of  comparative  inactivity  in  the  local  money  mar- 

1  [Owing  to  the  growth  of  deposit  banking  among  the  farming  classes, 
the  increasing  diversification  of  industry  in  the  agricultural  States,  Sub- 
treasury  operations,  and  the  offer  of  remunerative  rates  of  interest  on 
loans  in  New  York  during  the  fall,  the  net  autumnal  currency  movement 
since  1907  has  frequently  been  to  New  York.  See  E.  M.  Patterson,  Cer- 
tain Changes  in  New  York's  Position  as  a  Financial  Center,  Journal  of 
Political  Economy.  Vol.  XXI,  June,  1913,  pp.  523-539.] 

2  E.  W.  Kemmerer,  op.  cit.,  pp.  101-105. 


ST.  LOUIS  AND  NEW  YORK  295 

ket.  Concerning  this  period,  a  prominent  St.  Louis  banker 
writes :  "  For  the  first  eighteen  weeks  in  the  year  .  .  .  there 
is  comparatively  no  New  York  exchange  making  and  also  a 
nominal  demand  for  it,  and  likewise  an  easy,  quiet  money  mar- 
ket." .  .  . 

The  second  noticeable  movement  in  the  St.  Louis  money 
market  is  the  sharp  decline  in  the  relative  demand  for  money 
from  the  fore  part  of  May  to  about  the  first  of  June.  Ex- 
change on  New  York  rises  rapidly  at  this  time,  and  May  is 
the  month  of  heaviest  shipments  of  cash  to  the  East.  .  .  . 

The  high  exchange  rates  in  May,  and  the  resulting  eastward 
movement  of  money,  are  due  largely  to  the  fact  that  at  about 
this  time  in  St.  Louis  the  bills  of  boot,  shoe,  hardware,  and 
dry  goods  merchants  mature,  and  as  their  paper  is  held  largely 
in  the  East,  exchange  is  required  in  large  amounts.  The  re- 
sult is  large  payments  to  St.  Louis  banks,  the  building  up  of 
their  reserves,  and  resulting  reduction  of  their  credit  balances 
in  New  York  City. 

From  the  first  of  June  to  the  first  of  November  the  demand 
for  money  in  St.  Louis  relative  to  that  in  New  York  City  in- 
creases rapidly,  advancing  from  the  cheapest  money  in  the 
year  (twenty-first  week)  to  the  dearest  money  (forty- fourth 
week).  .  .  . 

This  greatly  increasing  relative  demand  for  money  in  St. 
Louis  is,  of  course,  attributable  to  the  crop-moving  require- 
ments. .  .  .  The  cashier  of  a  St.  Louis  bank  writes :  "  New 
York  exchange  .  .  .  always  goes  to  a  discount  here  in  the  fall 
of  the  year,  and  this  is  caused  by  the  large  cotton  drafts  drawn 
in  payment  of  cotton  shipped  out  from  the  Southwest.  The 
banks  down  there  either  send  us  drafts  drawn  on  New  England 
points  or  New  York,  or  else  they  send  drafts  drawn  on  the  two 
large  cotton  buyers  here,  who,  in  turn,  draw  their  drafts  on 
Eastern  points.  The  result  is  a  great  deal  of  exchange  comes 
in,  for  which  there  is  a  demand  for  currency."  The  resulting 
low  rates  of  exchange  continue  as  long  as  the  cotton  season 
lasts.  During  this  crop-moving  season  there  are  heavy  ship- 
ments of  cash  from  St.  Louis  to  the  Southern  States.  .  .  . 

After  about  the  first  week  in  November  the  relative  demand 


296  DOMESTIC  EXCHANGE 

for  money  in  St.  Louis  falls  off  rapidly  until  about  the  first  of 
December,  and  then  fluctuates  at  a  moderate  level  until  the  end 
of  the  year.  .  .  . 

The  rise  in  exchange  and  easing  up  of  the  St.  Louis  money 
market  in  the  latter  part  of  November  and  in  December  is  due 
to  the  decline  in  the  crop-moving  demand  for  cash,  particu- 
larly in  the  South,  and  the  return  movement  of  cash  from 
that  section,  .  .  .  which  begins  the  latter  part  of  November. 
Southern  banks  in  settling  their  St.  Louis  bills  first  use  their 
eastern  exchange  and  then  ship  currency.  The  upward  move- 
ment of  exchange  is  hastened  shortly  after  the  first  of  No- 
vember by  heavy  purchases,  for  about  four  weeks,  of  New 
York  exchange  by  dry  goods,  hardware,  and  boot-and-shoe 
houses  for  the  purpose  of  settling  their  eastern  accounts.  .  .  . 

DOMESTIC  EXCHANGE  IN  SAN  FRANCISCO  ON  NEW  YORK 

CITY 

1.  .  .  Before  taking  up  the  subject  of  seasonal  variations 
in  San  Francisco  domestic  exchange  rates  on  New  York  City, 
it  may  be  well  to  observe  that  in  a  number  of  respects  the  San 
Francisco  domestic  exchange  market  is  a  peculiar  one. 

In  the  first  place  the  principal  kind  of  money  in  circulation 
is  gold  coin  and  this  fact  materially  influences  the  range  of 
domestic  exchange  fluctuations,  i.  e,,  the  shipping  points. 
Concerning  this  matter  I  can  do  no  better  than  quote  from 
letters  of  Mr.  F.  L.  Lipman  of  the  Wells  Fargo  Nevada  Na- 
tional Bank.  Mr.  Lipman  writes  (under  date  of  February 
7,  1908)  :  "  In  the  East  the  medium  of  exchange  is  paper 
or  new  gold  by  weight.  In  California  it  is  current  gold  coin 
by  tale,  with  a  mingling  of  paper  and  new  gold.  The  first 
effect  of  an  upward  movement  of  exchange,  there,  is  that  at 
about  40  cents  per  $1,000  the  currency  shipping  point  is 
reached,  which  in  due  course,  drains  off  our  paper  money. 
At  approximately  $1.10  per  $1,000  the  gold  shipping  point  is 
reached.  Of  course  the  only  gold  that  can  be  economically 
shipped  is  new  gold.  Now  it  not  infrequently  happens  that 
the  demand  for  remittance  will  be  so  great  as  to  exhaust 

1  Ibid,,  pp.  118-121. 


SAN  FRANCISCO  EXCHANGE  MARKET  297 

(ist)  the  currency  and  (2d)  the  new  gold,  leaving  only  our 
current  gold,  for  which  there  is  practically  no  shipping  point, 
the  discount  on  worn  coin  being  practically  prohibitory." 

A  second  peculiarity  of  the  San  Francisco  exchange  market 
arises  from  the  fact  that  San  Francisco,  being  the  chief  port 
city  of  the  Pacific  coast  and  the  seat  of  one  of  the  United 
States  mints  and  subtreasury  offices,  is  the  recipient  of  large 
quantities  of  gold  from  gold-producing  regions,  i.  e.,  Cali- 
fornia, Alaska,  and  Australia.  The  United  States  mint  will 
issue  without  any  charge  its  transfer  drafts  on  the  subtreasury 
in  New  York  in  return  for  deposits  of  gold,  the  new  product 
of  mines,  or  for  deposits  of  imported  gold.  "  Frequently," 
writes  Mr.  Lipman,  "  this  usage  is  without  influence  on  our 
local  market,  as  when  large  importations  of  Australian  gold 
are  received  for  New  York  on  London  account.  At  other 
times  this  practice  of  the  Treasury  has  a  decided  effect  on  our 
exchange  market  as,  for  instance,  when  the  early  gold  ship- 
ments come  down  from  Alaska.  These  shipments  command 
the  service  of  the  Treasury  Department  to  the  full  amount 
thereof,  while  a  portion  at  least  of  the  proceeds  is  used  in 
payment  of  local  bills  for  supplies  to  Alaska  from  this  city. 
This  throws  on  the  market  an  additional  supply  of  exchange 
when  such  exchange  is  desired.  The  owners  of  the  gold,  how- 
ever, have  the  privilege  of  taking  gold  coin  instead  of  eastern 
exchange  from  the  Treasury,  and  this  alternative  tends  to 
bring  exchange  to  about  par.  The  Government  also  influ- 
ences exchange  from  the  other  side,  by  its  willingness  to  trans- 
mit money  by  telegraph  from  New  York  and  Chicago  to  this 
city."  .  .  . 

Professor  Carl  C.  Plehn  of  the  University  of  California, 
suggests  three  other  characteristics  of  the  San  Francisco  do- 
mestic exchange  market,  i.  e.,  ( i )  the  close  exchange  relations 
with  the  Orient,  (2)  the  fact  that  in  San  Francisco,  New  York 
bills  very  frequently  represent  merely  steps  in  a  general  arbi- 
trage transaction,  and  (3)  the  appreciable  interest  element 
involved  in  demand  transactions  because  of  the  distance  be- 
tween San  Francisco  and  New  York.  .  .  . 

From  the  beginning  of  January  to  about  the  first  of  March 
there  is  a  rapid  decline  in  the  relative  demand  for  money  in 


298  DOMESTIC  EXCHANGE 

San  Francisco,  resulting  in  the  lowest  level  of  the  year  during 
February. 

The  average  rate  of  exchange  rose  from  30  cents  discount 
in  the  first  week  to  $1.05  premium  in  the  seventh.  .  .  . 

.  .  .  Among  the  principal  factors  cheapening  money  in  San 
Francisco  at  this  time  and  forcing  up  exchange  may  be  men- 
tioned :  ( i )  the  fact  that  advances  which  have  been  made  for 
the  movement  of  general  crops  up  and  down  the  Pacific  coast 
are  being  repaid  very  rapidly;  (2)  the  demand  for  eastern 
exchange  with  which  to  pay  bills  incurred  for  holiday  pur- 
chases; and,  finally  (3),  the  latter  part  of  February,  the  desire 
of  taxpayers  to  discharge  eastern  obligations  and  get  movable 
funds  out  of  the  State  before  the  tax  returns  of  the  first  Mon- 
day in  March  are  made  to  the  assessor. 

From  the  fore  part  of  March  to  the  fore  part  of  June  the 
demand  for  money  in  San  Francisco  relative  to  New  York 
City  tends  to  increase.  .  .  . 

Among  the  causes  at  work  in  reducing  exchange  rates  at 
this  time  may  be  mentioned:  (i)  the  readjustment  after  the 
heavy  demands  for  exchange  which  were  made  anticipatory 
of  assessment  day:  (2)  preparation  for  the  second  installment 
of  taxes  which  become  delinquent  the  last  Monday  in  April; 
(3)  demand  for  funds  by  the  large  fruit  canneries  with  which 
to  buy  sugar  and  tin  in  preparation  for  the  annual  fruit  pack 
which  begins  in  May;  (4)  by  May  the  shipping  trade  in  green 
fruits  has  begun,  giving  rise  to  many  eastern  bills;  (5)  de- 
mand for  funds  for  equipping  fishing  companies  going  on 
long  trips.  .  .  . 

From  about  the  ist  of  July  to  the  fore  part  of  September 
there  is  an  almost  continuous  increase  in  the  relative  demand 
for  money  in  San  Francisco.  .  .  . 

.  .  .  During  August  and  September,  particularly  the  latter 
month,  substantial  transfers  of  cash  [are  made]  to  San  Fran- 
cisco by  the  United  States  subtreasury  at  New  York. 

This  decline  in  exchange  is  principally  due  to  the  large 
amount  of  eastern  credits  available  locally  at  this  time  from 
the  shipment  of  California  products,  especially  green  fruits, 
to  eastern  points ;  the  returns  for  such  shipments  being  usually 
available  in  either  Chicago  or  New  York  exchange.  .  .  .  The 


EXCHANGE  RELATIONS  290 

California  hay  and  grain  harvests  cause  considerable  demand 
for  funds  by  the  middle  of  July,  while  the  ships  returning 
from  the  fisheries  in  August  and  September  require  large  sums 
with  which  to  pay  their  crews. 

From  about  the  middle  of  September  (thirty- fourth  week) 
to  the  latter  part  of  October  (thirty-ninth  week)  New  York 
exchange  tends  to  rule  at  near  par.  .  .  . 

During  these  weeks  the  outward  movements  of  grain,  green 
fruit,  and  fish  tend  to  force  exchange  down,  while  the  fact 
that  this  is  the  quarter  of  large  receipts  of  gold  .  .  .  from 
Alaska,  making  it  a  period  of  large  receipts  of  gold  bullion 
at  the  Mint,  and  that  the  San  Francisco  Mint  makes  returns 
for  this  gold  in  gold  coin  or  New  York  exchange,  at  the 
option  of  the  owner  of  the  bullion,  tends  to  keep  New  York 
exchange  at  par. 

The  demand  for  money  in  San  Francisco  relative  to  New 
York  City  increases  rapidly  from  the  latter  part  of  October 
to  about  the  ist  of  December  when  it  reaches  its  highest  point 
in  the  year.  .  .  .  November  and  December  are  the  months 
of  largest  transfers  of  cash  to  San  Francisco  by  the  United 
States  subtreasury  in  New  York.  The  fall  in  exchange  dur- 
ing this  period  appears  to  be  due  primarily  to  the  outward 
movement  of  dried  fruits,  such  as  raisins,  prunes,  and  apricots. 
The  banks  pay  out  large  amounts  of  actual  coin  which  goes  to 
the  country,  and  receive  in  return  drafts  on  eastern  points 
which  build  up  their  eastern  balances.  This  also  represents 
the  most  active  part  of  the  northern  grain  season.  The  low 
point  of  the  year  for  exchange  is  about  the  last  week  in 
November  when  the  tax  collector  for  the  city  and  county  of 
San  Francisco  withdraws  large  sums  of  actual  coin  from  cir- 
culation and  locks  much  of  it  up  in  the  vaults  of  the  city  hall. 

December  is  a  month  in  which  the  relative  demand  for 
money  in  San  Francisco  lightens  considerably  as  the  result 
of  the  rapid  falling  off  of  the  crop-moving  demand.  .  .  .  The 
demand  for  remittances  to  the  East  for  January  ist  settle- 
ments tends  to  force  up  exchange  rates  at  the  end  of  the 
year.  .  .  . 


300  DOMESTIC  EXCHANGE 

CURRENCY  MOVEMENTS  BETWEEN  NEW  ENGLAND  AND  THE 
EASTERN  STATES 

J.  .  .  The  distance  between  New  York  City  and  the  prin- 
cipal New  England  cities  is  very  small,  and  there  is  a  great 
community  of  financial  interest  among  these  cities  and  New 
York.  Between  New  York  City  and  Boston  the  currency 
shipping  points  are  only  about  25  cents  premium  and  25  cents 
discount.  Single  financial  deals  between  New  York  City  and 
Boston  are  frequently  of  sufficient  moment  to  lead  to  consid- 
erable shipments  of  currency,  although  exchange  rates  pre- 
viously were  only  moderate.  The  relations  among  the  clear- 
ing-house banks  of  Boston  and  among  those  of  other  New 
England  cities  are  close,  so  that  when  one  bank  is  in  need  of 
New  York  funds  it  is  liable  to  obtain  them  from  another 
which  may  have  more  than  it  needs.  For  this  reason,  it  is 
said,  much  less  money  is  now  received  from  New  York  City 
and  shipped  there  than  was  the  case  a  few  years  ago.  .  .  . 

THE  DOMESTIC  EXCHANGES  DURING  THE  CRISIS  OF  1907  2 

There  is  no  part  of  our  banking  machinery  which  has  re- 
ceived so  little  elucidation  as  that  of  the  domestic  exchanges. 
Even  for  normal  times  the  subject  is  obscure,  and  the  writer 
therefore  ventures  upon  an  explanation  of  its  course  during 
a  period  of  crisis  with  hesitation,  and  he  is  by  no  means  con- 
fident that  important  considerations  may  not  have  been  over- 
looked. 

As  in  the  case  of  foreign  exchange,  domestic  exchange  rates 
fluctuate  within  limits  fixed  by  the  cost  of  shipping  money, 
and  also,  in  the  case  of  cities  distant  from  New  York,  by  the 
loss  of  interest  while  currency  is  in  transit.  The  quoted  rates 
apply  principally  to  business  between  banks,  the  rates  being 
determined  by  demand  and  supply.  A  Boston  bank,  for  ex- 
ample, receives  from  its  customers  New  York  drafts  and  also 
checks  drawn  on  banks  in  New  York  and  its  vicinity.  All 

i  Ibid.,  54.  55. 

2O.  M.  W.  Sprague,  History  of  Crises  under  the  National  Banking 
System,  Publications  of  the  National  Monetary  Commission,  Senate  Docu- 
ment No.  538,  6ist  Congress,  2d  Session,  pp.  293-297. 


IN  THE  CRISIS  OF  1907  301 

these  items  will  serve  to  build  up  its  balances  in  that  city.  On 
the  other  hand,  its  depositors  have  been  s'ending  out  checks, 
many  of  which  will  in  the  course  of  time  reach  New  York 
and  reduce  its  balances  there.  The  Boston  bank  will  also 
have  received  from  banks  of  New  York  and  from  banks  else- 
where items  for  collection  in  its  vicinity,  and  remittance  in 
ordinary  course  will  be  made  by  it  in  New  York  funds.  Sim- 
ilarly it  has  sent  away  items  for  collection  to  banks  in  other 
cities  upon  which  it  expects  a  like  remittance.  As  a  result 
of  all  these  various  influences  the  balances  of  the  Boston 
bank  may  either  increase  or  decrease.  If  they  increase  it 
may  be  ready  to  sell  exchange  to  other  Boston  banks  whose 
balances  are  running  low.  It  may  also  happen  that  the  bank 
is  desirous  of  reducing  its  New  York  balances,  and  in  that 
case  it  will  also  appear  as  a  seller  of  exchange  in  the  market. 

Now,  if  in  the  course  of  a  crisis  clearing-house  loan  certifi- 
cates become  the  principal  or  sole  medium  of  payment  between 
banks,  it  may  well  happen  that  a  bank  will  be  unwilling  to 
sell  exchange  unless  it  is  unusually  well  supplied  with  New 
York  funds.  By  the  sale  of  exchange  it  can  at  best  only 
secure  a  favorable  clearing-house  balance,  which  will  be  set- 
tled in  loan  certificates,  and  if  this  balance  should  be  unfa- 
vorable it  can  meet  it  by  taking  out  certificates  on  its  own 
account.  Each  bank,  therefore,  to  a  greater  extent  than  in 
normal  times,  is  obliged  to  rely  upon  itself  for  means  of  pay- 
ment in  New  York.  The  loan  certificate  does  indeed  yield 
a  return  or  involve  an  expense  of  6  or  7  per  cent.,  while  the 
return  on  New  York  balances  is  only  2  per  cent.  This  ad- 
vantage does  not,  however,  seem  to  have  induced  the  banks 
to  sell  exchange  as  freely  as  in  normal  times. 

This  is,  however,  not  the  only  disturbing  influence.  The 
Boston  bank  may  have  remitted  to  New  York  upon  items  col- 
lected by  it  for  other  banks  —  let  us  say  those  of  Phila- 
delphia —  but  it  may  happen  that  the  Philadelphia  banks  de- 
lay or  even  discontinue  remitting  to  New  York  upon  items 
sent  to  them  for  collection  by  banks  of  Boston  and  other 
cities.  The  Boston  bank  can  then  no  longer  rely  upon  what 
would  normally  serve  to  build  up  its  own  New  York  bal- 
ances. It  will  be  simply  acquiring  a  mass  of  unavailable 


302  DOMESTIC  EXCHANGE 

credits  at  scattered  points  throughout  the  country.  The  sup- 
ply of  New  York  exchange  which  it  might  have  been  willing 
to  sell  is  consequently  diminished,  and  the  premium  on  ex- 
change must  rise  to  a  point  at  which  it  will  tempt  some  of  the 
banks  to  sell  exchange,  even  though  it  intrenches  upon  their 
balances  with  agents  which  are  available  for  reserve. 

The  premium  would  naturally  be  especially  high  in  those 
cities  where  the  banks  were  most  unwilling  to  reduce  their 
New  York  balances.  Philadelphia  seems  a  case  in  point,  as 
its  deposits  with  reserve  agents,  which  were  $30,995,000  on 
August  22,  were  reduced  to  only  $29,389,000  on  December  3. 
At  that  time  the  premium  on  currency  in  Philadelphia  ranged 
from  $1.50  to  $3  per  $1,000.  It  is,  therefore,  a  reasonable 
conclusion  that  the  banks  were  strongly  disinclined  to  make 
use  of  their  New  York  balances.  In  a  few  cities  it  is  prob- 
able that  the  premium  reached  a  high  level  because  the  banks 
had  exhausted  their  New  York  balances.  St.  Louis  may  be 
mentioned  as  a  probable  example.  Being  a  central  reserve 
city,  its  banks  would  naturally  have  only  such  balances  in 
New  York  as  normal  business  requirements  made  necessary. 
The  dislocation  of  exchange  elsewhere  or  the  course  of  pay- 
ments between  New  York  and  St.  Louis  may  have  combined 
to  produce  such  a  balance  of  payments  as  would  have  required 
currency  shipments  if  the  St.  Louis  banks  had  remitted 
promptly  to  New  York. 

The  extent  to  which  banks  in  different  cities  delayed  or 
refused  to  remit  to  New  York  on  items  collected  by  them 
for  other  banks  cannot  be  determined.  Banks  in  one  city, 
very  naturally  and  honestly,  were  inclined  to  lay  the  blame 
upon  banks  elsewhere.  The  banks  in  other  places,  however, 
may  not  have  been  able  to  secure  payment  of  the  items  sent 
to  them  for  collection  from  other  banks  in  their  locality  with 
the  usual  promptness.  When  every  allowance  has  been  made, 
however,  there  can  be  no  question  that  banks  in  certain  cities, 
in  these  as  well  as  in  other  matters,  adopted  a  policy  wholly 
designed  to  strengthen  themselves  regardless  of  consequences. 

The  general  prevalence  of  the  premium  on  New  York  ex- 
change is,  as  we  have  seen,  accounted  for  in  part  by  the  use 
of  clearing-house  loan  certificates  in  settling  balances  between 


IN  THE  CRISIS  OF  1907  303 

banks  and  by  the  delay  in  remitting  in  New  York  funds  upon 
items  collected  for  other  banks.  It  seems  probable,  however, 
that,  taking  the  country  as  a  whole,  the  course  of  payments 
was  favorable  to  the  New  York  banks.  At  the  beginning  of 
November  withdrawals  for  crop-moving  purposes  have  in  re- 
cent years  begun  to  diminish,  except  to  the  South,  and  move- 
ments of  money  from  eastern  centers  are  distinctly  in  favor 
of  New  York  at  that  season  of  the  year.  If  this  were  indeed 
the  case  in  1907,  it  affords  still  another  reason  for  thinking 
that  the  New  York  banks  might  have  met  the  crisis  success- 
fully without  restricting  payments.  They  would  probably 
have  been  obliged  to  meet  only  withdrawals  arising  from  lack 
of  confidence  and  not  real  needs  for  crop-moving  purposes, 
such  as  would  have  increased  the  difficulties  of  the  situation 
had  the  crisis  begun  at  the  beginning  of  September. 

Finally,  it  should  be  noted  that  the  restriction  of  cash  pay- 
ments to  depositors  and  the  currency  premium  seem  to  have 
increased  the  demand  for  New  York  exchange.  Only  in  that 
city  was  it  possible  to  buy  any  considerable  quantity  of  money. 
Many  banks  in  various  parts  of  the  country  purchased  gold 
and  currency  at  a  premium  in  New  York  and,  instead  of 
drawing  on  their  own  balances,  then  entered  their  home  mar- 
ket as  purchasers  of  exchange  which  was  remitted  in  payment. 

In  the  few  instances  where  exchange  was  below  par  the 
currency  premium  was  a  more  direct  influence;  but  exchange 
could  not  have  dropped  to  the  low  figures  recorded  in  1893 
in  the  case  of  Chicago  [$30  discount  per  $1,000],  because  the 
Chicago  banks  in  1907  did  not  maintain  payments  among 
themselves  as  they  had  done  on  previous  occasions.  Exchange 
was  at  a  discount  only  in  those  cities  where  the  course  of 
payments  was  so  strongly  against  New  York  that  practically 
all  the  banks  found  their  balances  in  that  city  increasing. 
Chicago  might  have  been  expected  to  belong  to  this  group, 
but  its  banks  made  extensive  use  of  bills  derived  from  grain 
exports  to  secure  gold  which  was  shipped  directly  to  them. 
In  general,  exchange  was  at  a  discount,  or  at  par  only,  in  the 
Southern  States,  the  banks  of  which,  by  means  of  cotton  sales, 
are  normally  in  position  to  draw  money  from  the  northeastern 
part  of  the  country  during  the  late  autumn. 


304  DOMESTIC  EXCHANGE 

In  conclusion,  it  should  perhaps  be  pointed  out  that  the 
quoted  rates  of  exchange  were  often  without  much  signifi- 
cance. The  ordinary  course  of  dealings  was  so  completely 
disorganized  in  many  places  that  the  rates  were  purely  nominal, 
representing  little  or  no  actual  transactions. 


CHAPTER  XVIII 
FOREIGN  EXCHANGE 

THE  NATURE  OF  FOREIGN  EXCHANGE 

1  THE  bill,  or  order  to  pay  money  in  a  foreign  centre,  is  the 
commodity  that  is  actually  bought  and  sold  by  dealers  in  for- 
eign exchange,  but  it  is  better  for  the  moment  to  leave  bills 
out  of  consideration.  They  are  only  the  tangible  expression 
of  the  claim  for  money  in  another  centre,  and  at  this  early 
stage  of  our  inquiry  it  is  better  to  keep  our  minds  fixed  on 
what  is  at  the  back  of  the  bill,  namely,  the  money  in  a  foreign 
centre  to  which  it  gives  its  holder  a  claim.  The  French  buyer 
of  a  bill  on  London  buys  it,  as  a  rule,  because  by  sending  it 
to  his  English  correspondent  he  can  discharge  a  debt  to  him 
in  English  money.  What  he  really  buys  with  his  francs  is 
so  many  English  pounds,  and  the  labyrinth  of  the  foreign 
exchanges  is  much  easier  to  thread  if,  before  we  complicate 
the  question  by  talking  about  bills,  we  keep  our  eye  on  the 
comparatively  simple  problem  which  is  the  key  to  the  puzzle, 
namely,  the  exchange  of  one  country's  money  for  another's. 
Thus  stripped  to  its  naked  simplicity,  the  problem  begins 
to  look  as  if  it  wrere  not  a  problem  at  all,  and  a  critical  in- 
quirer may  be  excused  for  thinking  that  at  least  in  the  case 
of  countries  that  use  currencies  based  on  the  same  metal, 
there  ought  to  be  no  need  for  daily  quotations  of  rates  of 
exchange,  because  the  relative  value  of  their  moneys  ought 
to  be  constant.  It  is  a  natural  question  to  ask,  why  should 
there  be  these  daily  fluctuations,  and,  since  they  are  evidently 
there,  what  is  the  sense  or  purport  of  them?  The  answer  is, 
that  money  in  France  and  money  in  England  are  two  different 
things,  and  the  relative  value  of  two  different  things  is  almost 

1  Hartley  Withers,  Money  Changing,  pp.  30-35.    E.  P.  Button  and  Com- 
pany.    New   York.     1914. 

305 


306  FOREIGN  EXCHANGE 

certain  to  fluctuate.  Quite  apart  from  any  differences  in  the 
fineness  of  gold  coined  by  two  different  countries,  or  the  ease 
or  difficulty  with  which  a  credit  instrument  can  be  turned  into 
gold,  mere  distance  is  quite  enough  to  make  the  difference  that 
will  create  fluctuation  in  price.  New  York  and  Chicago  use 
exactly  the  same  currencies,  but  money  in  New  York  differs 
from  money  in  Chicago  by  being  nearly  a  thousand  miles 
away,  and  consequently  there  are  frequent  variations  in  their 
relative  value.  The  English  and  Australian  sovereigns  are 
identical  in  weight  and  fineness,  but  there  is  constant  fluctua- 
tion in  the  buying  power  of  the  English  sovereign  as  expressed 
in  its  brother  that  is  circulating  in  the  Antipodes. 

These  fluctuations  are  based  on  the  same  influence  that 
sways  the  movements  in  the  prices  of  all  goods  and  services 
that  are  bought  and  sold,  that  is,  the  influence  of  supply  and 
demand.  Just  as  the  price  of  boots,  Consols,  medical  advice, 
football  professionals,  or  anything  else  that  can  be  the  subject 
of  a  bargain,  will  depend  in  the  end  upon  the  number  of  peo- 
ple who  want  to  buy  them  compared  with  that  of  those  who 
want  to  sell  them,  at  or  near  a  certain  figure,  so  the  price  of 
English  pounds,  when  expressed  in  francs,  guilders,  milreis, 
or  Australian  sovereigns,  depends  on  the  number  of  people 
abroad  who  have  to  buy  money  in  England  as  compared  with 
the  number  of  those  who  have  money  in  England  to  sell. 
People  abroad  have  to  buy  money  in  England  when  they  owe 
money  to  Englishmen  and  want  to  pay  it;  and  they  have 
money  in  England  to  sell  when  Englishmen  owe  them  money. 

Jacques  Bonhomme  in  Paris  has  been  selling  shiploads  of 
Christmas  kickshaws  to  John  Robinson  in  London,  and  so 
has  thousands  of  English  pounds  due  to  him  by  the  said  Rob- 
inson. But  English  pounds,  as  such,  are  not  wanted  by  M. 
Bonhomme.  He  wants  to  sell  them,  to  turn  them  into  francs, 
the  currency  of  his  own  country,  with  which  he  makes  his 
daily  payments  at  home.  On  the  other  hand,  there  are  always 
plenty  of  Frenchmen  who  have  imported  English  goods  or 
have  had  services  rendered  by  English  bankers,  or  shipowners, 
or  insurance  companies,  and  so  want  to  buy  English  money 
wherewith  to  pay  their  English  creditors.  So  it  follows  that 
the  price  that  M.  Bonhomme  will  get  for  his  English  pounds 


NATURE  OF  FOREIGN  EXCHANGE  307 

will  depend  on  the  value  of  goods  and  services  that  other 
Frenchmen  have  been  selling  to  England,  so  producing  Eng- 
lish pounds  to  be  sold  in  Paris,  as  compared  with  the  value 
of  the  claims  that  have  to  be  met  in  London,  for  the  satis- 
faction of  which  English  pounds  have  to  be  bought.  If  the 
amount  of  English  money  on  offer  is  bigger  than  the  amount 
wanted,  down  will  go  the  price  of  the  English  pound  as  ex- 
pressed in  francs,  and  the  seller  in  francs  will  get  less  in  francs 
for  his  pound.  If  the  amount  of  English  money  \vanted  is 
the  bigger,  the  price  will  go  up,  and  the  seller  will  get  more 
for  his  pound.  When  the  price  goes  down,  the  exchange  is 
said  to  move  against  London,  because  there  is  a  depreciation 
in  the  value  of  the  sovereign  as  expressed  in  francs.  When 
it  goes  up  the  exchange  moves  in  favour  of  London,  because 
the  buying  power  of  the  sovereign  is  enhanced. 

The  process  is  exactly  the  same,  and  is  even  more  simple 
and  easy  to  understand  when  we  take  away  the  complication 
of  the  exchange  of  the  moneys  of  two  different  nations,  and 
look  at  it  at  work  between  two  distant  towns  of  the  same 
country.  If  in  the  course  of  trade  New  York  has  large  pay- 
ments to  make  in  Chicago,  money  in  Chicago  will  be  wanted 
in  New  York,  and  competition  there  will  send  up  the  price 
of  it,  so  that  a  dollar  in  Chicago  will  be  worth  more  for  the 
time  being  to  New  Yorkers  than  a  dollar  in  New  York,  and 
any  New  York  bank  or  firm  that  has  a  balance  or  a  credit  in 
Chicago  will  be  able  to  dispose  of  it  at  a  premium.  The  extent 
of  this  premium,  however,  will  obviously  be  limited  by  the 
expense  involved  in  sending  lawful  money,  as  the  Americans 
call  it,  from  New  York  to  Chicago.  If  wre  suppose,  for  the 
sake  of  simplicity,  that  the  cost  of  sending  a  dollar  and  insur- 
ing it  is  covered  by  a  cent,  no  one  in  New  York  will  pay  much 
more  than  one  dollar  and  a  cent  for  a  dollar  in  Chicago. 
Rather  than  do  so  he  will  send  his  dollar.  He  will  probably 
pay  a  small  fraction  more  to  save  himself  the  trouble  and  time 
involved  by  sending  and  insuring  money,  and  this  minute  frac- 
tion that  he  will  sacrifice  is  the  opportunity  of  the  exchange 
dealer,  who  will  send  money  to  Chicago,  and  put  himself  in 
funds  there,  and  so  be  able  to  supply  money  in  Chicago  to  any 
one  in  New  York  who  will  pay  for  it  at  the  rate  of  one  dollar 


308  FOREIGN  EXCHANGE 

and  one  cent  plus  any  profit  that  the  exchange  dealer  can 
squeeze  out  of  him. 

Viewed  in  this  simple  example  the  problem  of  exchange  has 
few  terrors.  It  is  merely  a  question  of  the  price  of  money 
in  one  place,  as  expressed  in  the  same  money  in  another,  with 
fluctuations  governed  by  supply  and  demand  and  limited  by 
the  cost  of  sending  money  from  place  to  place.  This  limita- 
tion does  not  mean  that  supply  and  demand  cease  to  govern 
the  market,  but  merely  that  at  a  point  supply  can  be  increased 
to  meet  any  demand  by  the  despatch  of  currency. 


"  FAVOURABLE  "  AND  "  UNFAVOURABLE  "  EXCHANGES 

1  The  general  feeling  with  regard  to  the  function  of  the 
exchanges,  as  giving  evidence  of  the  mercantile  (or  rather 
monetary)  situation  of  any  country,  is  indicated  by  the  usual 
phrase  of  a  "  favourable  or  unfavourable  state  of  the  ex- 
changes." A  phrase  which  occurs  so  frequently  in  all  bank- 
ing discussions  that  it  cannot  be  passed  over  without  remark. 
It  may  originally  have  implied  the  erroneous  theory  that  the 
object  of  commerce  is  to  attract  gold,  and  that  that  country 
towards  which  the  tide  of  bullion  sets  with  the  greatest  force 
is  ipso  facto  the  most  prosperous.  Political  economists,  from 
their  point  of  viexv,  are  correct  in  their  statement  that,  as  re- 
gards the  country  at  large  and  the  interchange  of  commodities, 
exports  and  imports  are  always  balanced,  and  that  both  the 
words  "  unfavourable  balance  of  trade  "  and  "  unfavourable 
exchanges  "  involve  fallacy.  But  merchants  and  bankers  are 
influenced  by  the  feeling,  that  at  any  given  moment  they  may 
be  under  greater  liabilities  for  imports  than  they  can  tem- 
porarily meet,  owing  to  the  system  of  credit  which  disturbs 
the  coincidence  of  payments  for  exports  and  imports,  though 
their  value  may  actually  be  equal ;  and  further,  by  the  anxiety 
as  to  the  possibility  of  meeting  these  liabilities  in  that  specific 
mode  of  payment  to  which  they  are  pledged,  namely,  in  gold 
or  convertible  notes.  When,  therefore,  in  banking  treatises. 
it  is  said  that  the  exchanges  are  favourable  to  any  particular 

1  Adapted   from  the  Rt.   Hon.  Viscount  Go«chen,  The  Theory  of  the 
Foreign  Exchanges,  pp.  85-88.    Effingham  Wilson.    London.     1913. 


SOURCES  OF  SUPPLY  309 

country,  it  should  be  understood  that  the  intention  is  simply 
to  state  the  fact  that  bills  of  that  country  upon  foreign  cities 
are  difficult  of  sale,  whilst  bills  drawn  upon  it  from  abroad 
are  at  a  premium,  indicating  an  eventual  influx  of  specie.  So, 
when  it  is  said  that  the  exchanges  are  unfavorable,  a  situation 
is  described  in  which  foreign  bills  are  in  great  demand,  and 
when,  consequently,  their  value  seems  likely  to  be  so  enhanced 
as  to  render  the  export  of  bullion  an  unavoidable  alternative. 


THE  ORIGIN  AND  SUPPLY  OF  FOREIGN  EXCHANGE 

1  Underlying  the  whole  business  of  foreign  exchange  is  the 
way  in  which  obligations  between  creditors  in  one  country 
and  debtors  in  another  have  come  to  be  settled  —  by  having 
the  creditor  draw  a  draft  directly  upon  the  debtor  or  upon 
some  bank  designated  by  him.  John  Smith  in  London  owes 
me  money.  I  draw  on  him  for  100  pounds,  take  the  draft 
around  to  my  bank  and  sell  it  at,  say,  4.86,  getting  for  it  a 
check  for  $486.00.  I  have  my  money,  and  I  am  out  of  the 
transaction. 

The  fact  that  the  gold  in  a  new  British  sovereign  (or  pound 
sterling)  is  worth  $4.8665  in  our  money  by  no  means  proves, 
however,  that  drafts  payable  in  pounds  in  London  can  always 
be  bought  or  sold  for  $4.8665  per  pound.  To  reduce  the 
case  to  a  unit  basis,  suppose  that  you  owed  one  pound  in  Lon- 
don, and  that,  finding  it  difficult  to  buy  a  draft  to  send  in  pay- 
ment, you  elected  to  send  actual  gold.  The  amount  of  gold 
necessary  to  settle  your  debt  would  cost  $4.8665,  in  addition 
to  which  you  would  have  to  pay  all  the  expenses  of  remitting. 
It  would  be  cheaper,  therefore,  to  pay  considerably  more  than 
$4.8665  for  a  one-pound  draft,  and  you  would  probably  bid  up 
until  somebody  consented  to  sell  you  the  draft  you  wanted. 

Which  goes  to  show  that  the  mint  par  is  not  what  governs 
the  price  at  which  drafts  in  pounds  sterling  can  be  bought, 
but  that  demand  and  supply  are  the  controlling  factors. 
There  are  exporters  who  have  been  shipping  merchandise  and 
selling  foreign  exchange  against  the  shipments  all  their  lives 

1  Adapted  from  Franklin  Escher.  The  Elements  of  Foreign  Exchange, 
pp.  3-14.  Bankers  Publishing  Company.  New  York.  1913. 


310  FOREIGN  EXCHANGE 

who  have  never  even  heard  of  a  mint  par  of  exchange.  All 
they  know  is,  that  when  exports  are  running  large  and  bills 
in  great  quantity  are  being  offered,  bankers  are  willing  to  pay 
them  only  low  rates  —  $4.83  or  $4.84,  perhaps,  for  the  com- 
mercial bills  they  want  to  sell  for  dollars.  Conversely,  when 
exports  are  running  light  and  bills  drawn  against  shipments 
are  scarce,  bankers  may  be  willing  to  pay  4.87  or  4.88  for 
them. 

For  a  clear  understanding  of  the  mechanics  of  the  exchange 
market  there  is  necessary  a  clear  understanding  of  what  the 
various  forms  of  obligations  are  which  bring  foreign  exchange 
into  existence.  Practically  all  bills  originate  from  one  of  the 
following  causes: 

1.  Merchandise  has  been  shipped  and  the  shipper  draws  his  draft 
on  the  buyer  or  on  a  bank  abroad  designated  by  him. 

2.  Securities  have  been  sold  abroad  and  the  seller  is  drawing  on 
the  buyer  for  the  purchase  price. 

3.  Foreign  money  is  being  loaned  in  this  market,  the  operation 
necessitating  the  drawing  of  drafts  on  the  lender. 

4.  Finance-bills  are  being  drawn,  i.  e.,  a  banker  abroad  is  allow- 
ing a  banker  here  to  draw  on  him  in  pounds  sterling  at  60  or  90 
days'   sight  in  order  that  the  drawer  of  the  drafts  may  sell  them 
(for  dollars)   and  use  the  proceeds  until  the  drafts  come  due  and 
have  to  be  paid. 

1.  Looking  at  these  sources  of  supply  in  the  order  in  which 
they  are  given,  it  is  apparent,  first,  that  a  vast  amount  of  for- 
eign exchange  originates  from  the  direct  export  of  merchan- 
dise from  this  country. 

Not  all  merchandise  is  drawn  against ;  in  some  cases  the 
buyer  abroad  chooses  rather  to  secure  a  dollar  draft  on  some 
American  bank  and  to  send  that  in  payment.  But  in  the  vast 
majority  of  cases  the  regular  course  is  followed  and  the  seller 
here  draws  on  the  buyer  there. 

2.  The  second  source  of  supply  is  in  the  sale  abroad  of 
stocks  and  bonds. 

Origin  of  bills  from  this  source  is  apt  to  exert  an  important 
influence  on  rates,  in  that  it  is  often  sudden  and  often  concen- 
trated on  a  comparatively  short  period  of  time.  The  an- 
nouncement of  a  single  big  bond  issue,  often,  where  it  is  an 
assured  fact  that  a  large  part  of  it  will  be  placed  abroad,  is 


SOURCES  OF  SUPPLY  311 

enough  to  seriously  depress  the  exchange  market.  Bankers 
know  that  when  the  shipping  abroad  of  the  bonds  begins, 
large  amounts  of  bills  drawn  against  them  will  be  offered  and 
that  rates  will  in  all  probability  be  driven  down. 

3.  The  third  great  source  of  supply  is  in  the  draft  which 
bankers  in  one  country  draw  upon  bankers  in  another  in  the 
operation  of  making  international  loans.     The  mechanism  of 
such  transactions  will  be  treated  in  greater  detail  later  on,  but 
without  any  knowledge  of  the  subject  whatever,  it  is  plain 
that  the  transfer  of  banking  capital,  say  from  England  to 
the  United  States,  can  best  be  effected  by  having  the  American 
house  draw  upon  the  English  bank  which  wants  to  lend  the 
money.     The  arranging  of  these  loans  means  the  continuous 
creation  of  very  large  amounts  of  foreign  exchange. 

4.  Drawing  of  so-called  "finance-bills,"  is  the  fourth  source 
whence  foreign  exchange  originates.     Whenever  money  rates 
become  decidedly  higher  in  one  of  the  great  markets  than  in 
the  others,  bankers  at  that  point  who  have  the  requisite  facili- 
ties and  credit,  arrange  with  bankers  in  other  markets  to  allow 
them  (the  bankers  at  the  point  where  money  is  high)  to  draw 
60  or  90  days'  sight  bills.     These  bills  can  then  be  disposed 
of  in  the  exchange  market,  dollars  being  realized  on  them, 
which  can  then  be  loaned  out  during  the  whole  life  of  the 
bills. 

These  are  the  principal  sources  from  which  foreign  ex- 
change originates  —  shipments  of  merchandise,  sales  abroad 
of  securities,  transfer  of  foreign  banking  capital  to  this  side, 
sale  of  finance-bills.  Other  causes  of  less  importance  —  in- 
terest and  profits  on  American  capital  invested  in  Europe,  for 
instance  —  are  responsible  for  the  existence  of  some  quantity 
of  exchange,  but  the  great  bulk  of  it  originates  from  one  of 
the  four  sources  above  set  forth. 

THE  SOURCES  OF  THE  DEMAND  FOR  FOREIGN  EXCHANGE  * 

Turning  now  to  consideration  of  the  various  sources  from 
which  spring  the  demand  for  foreign  exchange,  it  appears 
that  they  can  be  divided  about  as  follows: 

1  Ibid.,  pp.  15-24,  26,  31-33,  44- 


312  FOREIGN  EXCHANGE 

1.  The    need    for   exchange   with   which    to   pay    for   imports   of 
merchandise. 

2.  The    need    for    exchange    with    which    to    pay    for    securities 
(American  or  foreign)   purchased  by  us  in  Europe. 

3.  The  necessity  of  remitting  abroad  the  interest  and  dividends 
on  the  huge  sums  of  foreign  capital  invested  here,  and  the  money 
which  foreigners  domiciled  in  this  country  are  continually  sending 
home. 

4.  The  necessity  of  remitting  abroad  freight  and  insurance  money 
earned  here  by  foreign  companies. 

5.  Money  to  cover  American  tourists'  disbursements  and  expenses 
of  wealthy  Americans  living  abroad. 

6.  The  need  of  exchange  with  which  to  pay  off  maturing  foreign 
short-loans  and  finance-bills. 

1.  Payment  for  merchandise  imported  constitutes  probably 
the  most  important  source  of  demand  for  foreign  exchange. 
Practically  the  whole  amount  of  our  huge  importations  has 
had  to  be  paid  for  with  bills  of  exchange.     Whether  the  mer- 
chandise in  question  is  cutlery  manufactured  in  England  or 
coffee  grown  in  Brazil,  the  chances  are  it  will  be  paid  for  by 
a  bill  of  exchange  drawn  on  London  or  some  other  great 
European  financial  centre. 

2.  The  second  great  source  of  demand  originates  out  of  the 
necessity  of  making  payment  for  securities  purchased  abroad. 
So  far  as  the  American  participation  in  foreign  bond  issues 
is  concerned,  the  past  few  years  have  seen  very  great  develop- 
ments. 

Security  operations  involving  a  demand  for  foreign  ex- 
change are,  however,  by  no  means  confined  to  American  par- 
ticipation in  foreign  bond  issues.  Accumulated  during  the 
•ourse  of  the  past  half  century,  there  is  a  perfectly  immense 
amount  of  American  securities  held  all  over  Europe.  The 
greater  part  of  this  investment  is  in  bonds  and  remains  un- 
touched for  years  at  a  stretch.  But  then  there  come  times 
when,  for  one  reason  or  another,  waves  of  selling  pass  over 
the  European  holdings  of  "  Americans,"  and  we  are  required 
to  take  back  millions  of  dollars'  worth  of  our  stock  and  bonds. 
Such  selling  movements  do  not  really  get  very  far  below  the 
surface  —  they  do  not,  for  instance,  disturb  the  great  blocks 
of  American  bonds  in  which  so  large  a  proportion  of  many  of 
the  big  foreign  fortunes  are  invested.  The  same  thing  is  true 


SOURCES  OF  DEMAND  313 

with  stocks,  though  in  that  case  the  selling  movements  are 
more  frequent  and  less  important. 

3.  So  great  is  the  foreign  investment  of  capital  in  this  coun- 
try that  the  necessity  of  remitting  the  interest  and  dividends 
alone    means    another    continuous    demand    for    very    large 
amounts  of  foreign  exchange.     Estimates  of  how  much  Eu- 
ropean money  is  invested  here  are  little  better  than  guesses. 
The  only  sure  thing  about  it  is  that  the  figures  run  well  up  into 
the  billions  and  that  several  hundred  millions  of  dollars'  worth 
of  interest  and  dividends  must  be  sent  across  the  water  each 
year.     At  the  interest  periods  at  the  beginning  and  middle  of 
each  year  it  becomes  apparent  how  large  a  proportion  of  our 
bonds  are  held  in  Europe  and  how  great  is  the  demand  for 
exchange  with  which  to  make  the  remittances  of  accrued  inter- 
est.    At  such  times  the  incoming  mails  of  the  international 
banking  houses  bulge  with  great  quantities  of  coupons  sent 
over  here  for  collection.     For  several  weeks  on  either  side  of 
the  two  important  interest  periods,  the  exchange  market  feels 
the  stimulus  of  the  demand  for  exchange  with  which  the  pro- 
ceeds of  these  masses  of  coupons  are  to  be  sent  abroad. 

4.  Freights  and  insurance  are  responsible  for  a  fourth  im- 
portant  source  of   demand   for   foreign  exchange.     A  walk 
along  William  Street  in  New  York  is  all  that  is  necessary 
to  give  a  good  idea  of  the  number  and  importance  of  the  for- 
eign companies  doing  business  in  the  United  States.     In  some 
form  or  other  all  the  premiums  paid  have  to  be  sent  to  the 
other  side.     Times  come,  of  course,  like  the  year  of  the  Bal- 
timore fire,  when  losses  by  these  foreign  companies  greatly 
outbalance  premiums  received,  the  business  they  do  thus  re- 
sulting in  the  actual  creation  of  great  amounts  of  foreign 
exchange,  but  in  the  long  run  —  year  in,  year  out  —  the  re- 
mitting abroad  of  the  premiums  earned  means  a  steady  de- 
mand for  exchange. 

With  freights  it  is  the  same  proposition,  except  that  the 
proportion  of  American  shipping  business  done  by  foreign 
companies  is  much  greater  than  the  proportion  of  insurance 
business  done  by  foreign  companies.  An  estimate  that  the 
yearly  freight  bill  amounts  to  $150,000,000  is  probably  not  too 
high.  That  means  that  in  the  course  of  every  year  there  is 


314  FOREIGN  EXCHANGE 

a  demand  for  that  amount  of  exchange  with  which  to  remit 
back  what  has  been  earned  from  us. 

5.  Tourists'  expenditures  abroad  are  responsible  for  a  fur- 
ther heavy  demand  for  exchange.     The  sums  spent  by  Amer- 
ican tourists  in  foreign  lands  annually  aggregate  a  very  large 
amount  —  possibly  as  much  as  $175,000,000  —  all  of  which 
has  eventually  to  be  covered  by  remittances  of  exchange  from 
this  side. 

Then  again  there  must  be  considered  the  expenditures  of 
wealthy  .Americans  who  either  live  abroad  entirely  or  else 
spend  a  large  part  of  their  time  on  the  other  side.  By  these 
expatriates  money  is  spent  extremely  freely,  their  drafts  on 
London  and  Paris  requiring  the  frequent  replenishment,  by 
remittances  of  exchange  from  this  side,  of  their  bank  bal- 
ances at  those  points.  Furthermore,  there  must  be  consid- 
ered the  great  amounts  of  American  capital  transferred  abroad 
by  the  marriage  of  wealthy  American  women  with  titled  for- 
eigners. Such  alliances  mean  not  only  the  transfer  of  large 
amounts  of  capital  en  bloc,  but  mean  as  well,  usually,  an 
annual  remittance  of  a  very  large  sum  of  money.  No  account 
of  the  money  drained  out  of  the  country  in  this  way  is  kept, 
of  course,  but  it  is  an  item  which  certainly  runs  up  into  the 
tens  of  millions. 

6.  Lastly,  there  is  the  demand   for  exchange  originating 
from  the  paying  off  of  the  short-term  loans  which  European 
bankers  so  continuously  make  in  the  American  market. 

These  loaning  operations,  it  must  be  understood,  both  orig- 
inate exchange  and  create  a  demand  for  it.  They  were  men- 
tioned as  one  of  the  sources  from  which  exchange  originates, 
and  now  as  one  of  the  sources  from  which,  during  the  course 
of  every  year,  springs  a  demand  for  a  very  great  quantity  of 
exchange. 

In  a  .general  way,  it  may  be  pointed  out,  the  sources  of  de- 
mand for  exchange  conform  with  influences  which  cause  ex- 
change to  go  up,  and  the  sources  of  supply  of  exchange  con- 
stitute causes  which  make  for  low  rates. 

It  is  to  be  noted,  however,  that  money  rates  are  a  great 
factor  influencing  foreign  exchange.  Whenever  money  is 
cheap  at  any  given  centre,  and  borrowers  are  bidding  only 


FORCES  AFFECTING  EXCHANGE  RATES  315 

low  rates  for  its  use,  lenders  seek  a  more  profitable  field  for 
the  employment  of  their  capital. 

Money  rates  in  the  New  York  market  are  not  often  less 
attractive  than  those  in  London,  so  that  American  floating 
capital  is  not  generally  employed  in  the  English  market,  but 
it  does  occasionally  come  about  that  rates  become  abnormally 
low  here  and  that  bankers  send  away  their  balances  to  be 
loaned  out  at  other  points.  Such  a  time  was  the  long  period 
of  stagnant  money  conditions  following  the  1907  panic. 
Trust  companies  and  banks  who  were  paying  interest  on  large 
deposits  at  that  time  sent  very  large  amounts  of  money  to  the 
other  side  and  kept  big  balances  running  with  their  correspond- 
ents at  such  points  as  Amsterdam,  Copenhagen,  St.  Peters- 
burg, etc. —  anywhere,  in  fact,  where  some  little  demand  for 
money  actually  existed.  Demand  for  exchange  with  which  to 
send  this  money  abroad  was  a  big  factor  in  keeping  exchange 
rates  at  their  high  level  during  all  that  long  period. 

High  money  rates  at  some  given  foreign  point  as  a  factor 
in  elevating  exchange  rates  on  that  point  might  almost  be  con- 
sidered as  a  corollary  of  low  money  here,  but  special  consid- 
erations often  govern  such  a  condition  and  make  it  worth 
while  to  note  its  effect.  Suppose,  for  instance,  that  at  a  time 
when  money  market  conditions  all  over  the  world  are  about 
normal,  rates,  for  any  given  reason,  begin  to  rise  at  some 
point,  say  London.  Instantly  a  flow  of  capital  begins  in  that 
direction.  In  New  York,  Paris,  Berlin,  and  other  centres 
it  is  realized  that  London  is  bidding  better  rates  for  money 
than  are  obtainable  locally,  and  bankers  forthwith  make  prep- 
arations to  increase  the  sterling  balances  they  are  employing 
in  London.  Exchange  on  that  particular  point  being  in  such 
demand,  rates  begin  to  rise,  and  continue  to  rise,  according 
to  the  urgency  of  the  demand. 

The  international  money  markets  are  a  most  decidedly  com- 
plex proposition,  and  there  is  literally  never  a  time  when 
several  influences  tending  to  put  exchange  rates  up  are  not  con- 
flicting with  several  influences  tending  to  put  rates  down. 
The  actual  movement  of  the  rate  represents  the  relative 
strength  of  the  two  sets  of  influences.  To  be  able  to  "  size 
up  "  the  influences  present  and  to  gauge  what  movement  of 


316  FOREIGN  EXCHANGE 

rates  they  will  result  in,  is  an  operation  requiring,  first,  knowl- 
edge, then  judgment.  The  former  qualification  can  perhaps 
be  derived,  in  small  degree,  from  study  of  the  foregoing  pages. 
The  latter  is  a  matter  of  mental  calibre  and  experience. 


The  foreign  trade  of  the  United  States  has  increased  dur- 
ing the  last  forty  years  about  370  per  cent.  .  .  .  This  in- 
crease .  .  .  reflected  not  alone  our  own  marvellous  develop- 
ment, but  as  well  the  wonderful  growth  of  trade  throughout 
the  world.  The  United  States  stands  third  among  the  coun- 
tries of  the  world,  its  foreign  trade  being  exceeded  only  by 
that  of  the  United  Kingdom  .  .  .  and  Germany.  .  .  . 

Our  imports  and  exports 2  are  being  financed  more  and 
more  by  means  of  what  are  known  as  commercial  letters  of 
credit.  .  .  .  An  explanation  of  the  operation  of  the  commer- 
cial letter  of  credit  will  .  .  .  disclose  the  methods  and  condi- 
tions under  which  our  imports  are  financed. 

The  commercial  letter  of  credit  is  an  authorization,  say  of 
an  American  bank  to  its  London  correspondent,  to  honor 
drafts  for  its  account  drawn  at  various  tenors  by  foreign 
shippers  or  others  against  shipments  of  merchandise  to  this 
country.  These  credits  are  of  two  kinds,  documentary  and 
clean.  Under  the  documentary  credit  the  London  bank  is 
authorized  to  accept  drafts  for  the  account  of  the  American 
bank  only  when  the  bill  of  exchange  is  accompanied  by  cer- 
tain documents  described  in  the  letter  of  credit.  These  docu- 
ments may  be  the  bills  of  lading  for  the  goods,  consular  in- 
voices, insurance  certificates  and  possibly  other  papers.  Prob- 
ably a  large  proportion  of  such  credits  requires  that  drafts 
be  drawn  at  sixty  or  ninety  days'  sight.  So  many  elements 
of  danger  are  involved  in  financing  commodities  under  com- 

1  Adapted  from  Frederick  I.    Kent,  Financing  Our  Foreign  Trade,  The 
Annals  of  the  American  Academy  of  Political  and  Social  Science,  Vol. 
XXXVI,  No.  3,  November,  1910,  pp.  492-500. 

2  [The  method  explained  would  apply  without  qualification  to  our  im- 
ports generally  prior  to  1914,  whether  coffee  from  Brazil,  hides  from  the 
Levant,   or  textiles    from   France.     The   recent  and  growing  practice   of 
drawing  on  New  York  rather  than  on  London  is  discussed  later  in  this 
chapter.] 


COMMERCIAL  LETTERS  OF  CREDIT  317 

mercial  letters  of  credit,  even  where  the  control  of  the  goods 
is  given  to  the  bank  issuing  the  credit  or  its  agents,  that  the 
financial  standing  of  those  asking  for  credits  must  be  the  first 
consideration  in  their  issuance.  Dishonesty  on  the  part  of 
the  shipper,  resulting  in  a  drawing  under  the  credit  against 
forged  documents  or  against  shipments  of  inferior  merchan- 
dise, is  always  possible,  and  the  financial  responsibility  of  the 
buyer  of  the  credit  is  all  that  stands  between  the  banker  issuing 
the  credit  and  a  loss  in  such  cases. 

In  order  to  obtain  a  clear  understanding  of  the  working  of 
a  commercial  letter  of  credit,  we  will  take  a  concrete  example 
and  follow  its  every  transaction.  An  importer  of  coffee  (A) 
in  New  York  purchases  a  certain  number  of  bags  of  coffee 
from  an  exporter  (B)  in  Brazil.  A  agrees- to  furnish  B  with 
a  commercial  letter  of  credit.  B  is  not  in  position,  we  will 
say,  to  await  the  arrival  of  the  coffee  in  New  York  and  the 
return  of  a  remittance  before  receiving  his  pay.  A  on  the 
other  hand  is  unable  to  remit  B  for  the  coffee  before  its  receipt 
and  sale  to  his  customers.  A  goes  to  his  banker  in  New  York 
and  requests  him  to  authorize  B  to  draw  upon  the  New  York 
banker's  London  correspondent  at  ninety  days'  sight  with 
bills  of  lading  for  coffee  to  the  amount  of  the  purchase  at- 
tached to  the  draft,  consular  invoice  and  insurance  certifi- 
cate, if  B  is  to  furnish  insurance.  If  A's  banker  is  willing 
to  extend  the  credit  he  writes  a  letter  (or  uses  a  printed  form), 
requesting  his  London  banker  to  accept  B's  drafts  upon  presen- 
tation under  the  conditions  already  mentioned  and  others  of 
minor  importance.  This  letter  is  issued  in  duplicate,  one  copy 
going  to  the  London  banker,  the  other  being  delivered  to  A. 
A  then  mails  the  copy  received  by  him  to  B.  B  thereupon 
arranges  to  ship  the  coffee,  obtains  the  bill  of  lading,  invoice, 
etc.,  and  takes  them  with  the  copy  of  the  credit  to  his  banker 
in  Brazil.  A  draft  is  then  drawn  on  the  London  bank  under 
the  terms  of  the  credit  at  ninety  days'  sight  and  is  discounted 
by  the  Brazilian  banker,  the  proceeds  being  placed  to  the 
credit  of  B's  account  or  given  to  him  in  the  form  of  a  check 
or  cash.  The  Brazilian  banker  then  forwards  the  draft  and 
documents,  except  such  documents  as  the  instructions  may 
require  to  be  forwarded  direct  to  New  York,  to  his  London 


318  FOREIGN  EXCHANGE 

banker.  He  may  secure  discount  of  the  bill  at  once  by  cable 
or  await  its  arrival  in  London  before  doing  so,  or  he  may 
^request  his  London  banker  to  have  the  bill  accepted  and  hold 
it  for  maturity.  If  the  bill  is  discounted  the  Brazilian  banker 
may  draw  against  it  immediately  and  thus  put  himself  in 
funds  to  purchase  other  coffee  bills.  Upon  receipt  of  the  bill 
by  the  London  correspondent  it  is  presented  to  the  London 
banker  on  whom  it  is  drawn  for  acceptance.  The  acceptor 
bank  examines  the  documents  and  if  they  are  drawn  accord- 
ing to  the  terms  of  the  credit  accepts  the  draft  and  returns  it 
to  the  correspondent  of  the  Brazilian  bank,  retaining  the  docu- 
ments, which  it  then  forwards  to  the  New  York  bank  which 
opened  the  credit.  In  accepting  the  draft  the  London  bank 
has  in  effect  agreed  to  pay  it  at  the  end  of  ninety  days,  or, 
figuring  grace,  ninety-three  days.  Upon  maturity  payment  is 
made  and  the  amount  is  charged  to  the  account  of  the  issuing 
New  York  bank.  Upon  receipt  of  the  documents  the  New 
York  bank  delivers  them  to  its  customer  under  a  trust  receipt 
or  against  collateral,  and  the  latter  is  then  in  position  to  obtain 
the  goods.  Ten  days  before  the  bill  of  exchange  is  due  in 
London  the  New  York  bank  collects  the  amount  from  A,  to- 
gether with  the  commission  agreed  upon  when  the  credit  was 
opened,  and  remits  the  amount  to  its  London  banker  to  meet 
the  draft.  On  all  such  transactions  the  London  banker,  while 
not  himself  advancing  any  money,  is  extending  a  credit  for 
which  he  charges  the  New  York  bank  a  commission.  The 
result  is  that  we  are  paying  tribute  to  European  bankers 
amounting  to  an  immense  sum  annually  for  the  purpose  of 
financing  our  imports. 

The  fact  that  London  exchange  is  more  marketable  gen- 
erally throughout  the  world  than  New  York  exchange  is  one 
of  the  principal  reasons  why  it  is  necessary  for  us  to  issue 
credits  upon  London  instead  of  upon  New  York. 

Our  imports  are  distributed  generally  throughout  the  United 
States.  The  importers,  however,  are  mostly  situated  at  the 
ports  of  entry.  A  very  large  proportion  of  them  obtain  their 
credits  through  New  York  institutions,  although  some  of  them 
deal  direct  with  foreign  bankers. 

Probably  a  smaller  proportion  of  our  exports  is  financed  by 


FINANCING  COTTON  SHIPMENTS  319 

means  of  commercial  letters  of  credit  than  of  our  imports. 
Different  commodities  are  handled  in  accordance  with  special 
customs  which  have  grown  up  around  them,  due  partly  to 
trade  conditions  and  partly  to  the  nature  of  the  products. 
Sellers  of  grain  usually  draw  at  sixty  days'  sight  upon  the 
foreign  buyer  instead  of  under  a  bank  credit.  These  bills, 
under  the  customs  prevailing  in  most  foreign  countries,  may 
be  rebated  by  the  foreign  buyer  whenever  he  desires  to  obtain 
the  goods  at  the  "  bank  rate  "  or  I  per  cent,  under  the  bank 
rate,  or  such  other  rate  as  custom  in  the  country  on  which  the 
drafts  are  drawn  requires.  Such  drafts,  with  bills  of  lading 
and  such  other  documents  as  are  necessary,  are  purchased  by 
American  banks  and  are  forwarded  by  them  to  their  Euro- 
pean correspondents.  The  American  banker  is  obliged  to 
advance  the  money  on  such  paper,  unless  he  draws  his  own 
time  bills  against  them,  until  such  time  as  they  are  rebated. 
In  the  case  of  grain  bills  the  average  time  rebated  is  probably 
around  fifty-six  days,  which  places  the  American  bank  in 
possession  of  demand  foreign  exchange,  against  which  it  can 
draw  in  order  to  reimburse  itself  with  the  loss  of  a  very  few 
days'  interest 

Flour  bills,  which  are  financed  in  the  same  manner  as  grain 
bills,  usually  run  nearly  to  maturity  before  they  are  rebated, 
although  the  condition  of  the  discount  market  sometimes  in- 
fluences the  purchaser,  and  causes  him  to  take  the  bills  up  more 
promptly.  Many  foreign  shipments  are  made  under  three- 
day  sight  bills,  which  uses  the  money  of  the  American  banks 
making  the  advance  from  four  to  seven  days  or  more,  depend- 
ing upon  whether  the  laws  of  the  country  on  which  the  bills 
are  drawn  allow  grace  or  not  and  whether  the  bills  are  pur- 
chased with  intervening  days  before  the  sailing  of  steamers. 
Other  classes  of  bills  are  drawn  at  sight.  This  includes  a 
portion  of  our  lumber  shipments  and  miscellaneous  articles. 
Where  shipments  are  made  on  sailing  vessels,  drafts  are  fre- 
quently drawn  at  four  or  six  months'  sight,  and  many  other 
transactions  go  through  against  cable  payments. 

As  nearly  40  per  cent,  of  our  exports  consist  of  cotton,  the 
method  under  which  it  is  financed  is  worthy  of  special  con- 
sideration. Cotton  bills  are  ordinarily  of  two  kinds:  docu- 


320  FOREIGN  EXCHANGE 

mentary  payment  bills  and  bills  drawn  upon  bankers.  Docu- 
mentary payment  bills,  which  are  drawn  upon  cotton  mer- 
chants or  spinners  at  sixty  or  ninety  days'  sight  or  other 
tenors,  are  handled  in  the  same  manner  as  flour  bills.  The 
cotton  merchant  accepts  the  draft  upon  presentation  and  re- 
bates it  when  the  goods  arrive,  or  when  he  desires  to  obtain 
the  cotton.  A  small  percentage  of  cotton  is  handled  in  this 
way.  Most  of  the  commodity  is  financed  by  means  of  credits 
opened  by  the  foreign  buyer  through  his  banker.  Various 
abuses  have  developed  under  this  system,  which  have  caused 
losses  running  into  millions  of  dollars  to  all  of  the  various 
parties  engaged  in  carrying  the  transactions  to  their  close. 
These  losses  have  only  been  possible  because  of  the  turning 
over  of  credits  by  the  foreign  buyers  to  irresponsible  concerns 
in  America  in  their  endeavor  to  obtain  cotton  at  lower  prices 
than  their  competitors.  A  foreign  buyer  makes  arrangements 
with  certain  American  concerns  to  cable  him  offers  of  cotton. 
The  American  firms  whose  offers  are  accepted  receive  cable- 
grams from  the  buyer  advising  them  of  the  acceptance  of 
their  offers  and  giving  them  the  names  of  the  foreign  bankers 
on  whom  the  drafts  in  payment  of  the  cotton  are  to  be  drawn. 
The  American  sellers  thereupon  ship  the  cotton  to  the  buyer 
under  bills  of  lading  drawn  to  the  shipper's  order  and  en- 
dorsed in  blank.  The  bills  of  lading  are  then  attached  to 
drafts  drawn  upon  the  bankers  designated  by  the  buyer  at  the 
given  tenor,  which  is  usually  sixty  or  ninety  days.  This  ex- 
change is  then  sold  in  the  market  to  the  highest  bidder  or  it 
is  forwarded  to  New  York  to  be  sold  in  the  same  manner  upon 
arrival.  The  American  exchange  buyers  have  no  means  what- 
ever of  designating  whose  bills  shall  be  upon  the  market,  as 
the  sellers  are  all  agents  of  the  European  buyers.  The  Amer- 
ican exchange  houses  in  their  need  for  exchange  to  meet  the 
demands  of  their  importers  have  accepted  the  bills  offered  in 
the  market,  each  exchange  man  endeavoring  to  keep  his 
"  water  line"  on  weak  names  as  low  as  possible.  If  the  Eu- 
ropean buyers  only  dealt  with  first-class  houses  only  first-class 
bills  would  be  offered,  but  when  they  deal  with  second-  or 
third-rate  houses,  or  houses  with  no  standing  whatever,  such 


FINANCING  COTTON  SHIPMENTS  321 

bills  drawn  upon  prime  European  banks  come  upon  the  mar- 
ket. 

The  American  exchange  buyers  having  the  cotton  as  col- 
lateral while  the  drafts  are  on  the  water,  and  then  having 
the  acceptance  of  a  prime  European  bank  for  the  sixty  or 
ninety  days  following  before  maturity  of  the  draft,  have  ac- 
cepted these  risks,  although  unwillingly,  for  want  of  better 
bills.  They  endeavor  to  protect  themselves  as  far  as  pos- 
sible by  trying  to  buy  bills  only  of  those  in  whose  honesty 
they  have  reason  to  believe,  whether  they  have  any  capital 
back  of  them  or  not.  If  the  cotton  were  actually  shipped 
under  a  bona  fide  order,  any  fluctuation  in  the  value  of  the 
cotton  which  they  accepted  as  collateral,  although  taken  en- 
tirely without  margin,  would  probably  cause  them  neither  loss 
nor  friction.  They  have  run  the  risk,  however,  of  having 
forged  documents  forced  upon  them  which  did  not  represent 
goods,  or  exchange  that  was  drawn  without  authority.  Lines 
which  exchange  buyers  are  willing  to  take  from  each  cotton 
shipper  before  acceptance,  and  before  the  name  of  a  prime 
European  banker  is  added  to  the  paper,  have  to  be  based  upon 
this  consideration. 

The  old  form  of  the  cotton  bill  of  lading  which  has  been 
signed  by  freight  agents  or 'their  assistants  or  others  has  been 
an  instrument  not  possible  to  authenticate.  This  was  par- 
ticularly dangerous,  due  to  the  manner  in  which  bills  of  lading 
were  issued.  They  were  formerly  given  out  to  the  shippers, 
who  filled  them  in  and  returned  them  to  the  railroad  agent, 
who  in  turn  often  signed  them  without  having  any  knowledge 
as  to  whether  the  goods  called  for  by  the  bill  of  lading  were 
in  his  possession  or  not.  Under  a  new  system  bills  of  lading 
are  not  to  be  given  up  until  the  goods  are  actually  in  possession 
of  the  railroads.  This  system,  which  calls  for  validation  cer- 
tificates, numbered  and  printed  upon  a  specially  protected 
water-mark  paper,  to  be  attached  to  the  bills  of  lading  in  such 
manner  as  to  make  it  practically  impossible  to  remove  them 
without  detection,  went  into  effect  September  I,  1910,  and  it 
is  confidently  hoped  that  it  will  give  sufficient  added  safety 
to  the  bills  of  lading  of  American  railroads  to  satisfy  the  for- 
eign bankers. 


-22  FOREIGN  EXCHANGE 

*J 

The  very  act  of  guaranteeing  such  bills  is  recognized  by 
foreign  bankers  as  being  wrong  in  principle,  and  while  they 
are  requesting  that  American  exchange  buyers  guarantee  bills 
of  lading  for  exports  yet  on  the  other  hand  they  particularly 
call  attention  to  the  fact  that  no  bills  of  lading  which  pass 
through  their  hands  for  imports  to  the  United  States  are  guar- 
anteed by  them  in  any  way,  shape,  or  manner. 

CREDIT  RISKS  OF  DRAFTS  DRAWN  ON  BUYERS  ABROAD 

1  Many  American  manufacturers  do  not  realize  the  essen- 
tial "  credit "  element  of  transactions  on  the  basis  of  drafts 
drawn  on  foreign  customers.  .  ,  .  The  exporter  has  received 
an  order;  he  purchases  the  goods  covered  by  this  order  from 
the  manufacturer,  and  should  the  customer  change  his  mind 
the  exporter  may  suffer  a  loss.  Or  the  customer  refuses  to 
accept  the  goods,  and  the  exporter  may  again  suffer  a  loss. 
Or  the  customer  may  accept  the  goods  and  the  draft,  but  fail 
to  pay,  and  the  exporter  once  more  is  the  loser.  .  .  . 

.  .  .  The  turning  over  of  the  bill  of  lading  vests  the  prop- 
erty right  to  the  goods  in  the  customer.  The  customer  either 
pays  the  value  of  the  draft  in  cash  ("  documents  against  pay- 
ment," abbreviated  d/p)  or  accepts  the  draft  for  payment  at 
some  future  date,  which  is  the  more  customary  course  ("  docu- 
ments against  acceptance,"  d/a).  Even  in  the  case  of  d/p 
drafts,  payment  by  the  customer  may  be  postponed;  instead  of 
paying  cash  he  accepts  the  draft  at  one  to  three  months,  but 
neither  the  documents  nor  the  goods  are  turned  over  to  him. 
He  may  want  to  wait  until  he  has  sold  the  goods,  on  the  basis 
of  samples,  perhaps,  and  the  goods  are  warehoused  until  he 
can  pay  the  amount  of  the  draft  into  the  bank  or  to  the  for- 
warding agency.  This  is  frequently  done  in  the  Far  East. 
Here  the  banks  maintain  so-called  "  godowns  "  for  this  pur- 
pose. The  goods  are  occasionally  turned  over  to  the  customer 
for  warehousing  purposes  against  the  so-called  "  trust  receipt." 
One  important  feature  of  "  acceptance  "  of  the  draft  by  the 
customer  is  the  fact  that  it  forms  an  acknowledgment  of  in- 

1  Adapted  from  Archibald  J.  Wolfe,  Foreign  Credits,  pp.  22,  23,  Special 
Agents  Series  —  No.  62.  Department  of  Commerce  and  Labor.  Wash- 
ington. 1913. 


ENGLAND  DRAWS  FEW  BILLS  323 

debtedness,  which  it  is  then  unnecessary  to  prove  item  by  item 
in  case  of  litigation.  In  most  countries  acceptances  are  far 
simpler  to  collect  judicially  than  open  accounts.  When  an 
accepted  draft  is  unpaid  it  is  "  protested,"  and  the  debtors 
may  be  proceeded  against  without  further  trouble. 

Frequently  open  accounts  may  be  neglected  by  a  customer 
who  may  find  himself  for  some  reason  short  of  immediately 
available  funds,  but  to  neglect  the  payment  of  an  accepted 
draft  is  regarded  in  the  trade  and  by  banks  as  so  serious  a 
matter  that  the  drawee  would  lose  caste  with  the  banks ;  over- 
sea buyers  endeavor  in  most  cases  to  honor  accepted 
drafts. 


ENGLAND  DRAWS  FEW  BILLS,  BUT  ACCEPTS  MANY  — 
THE  REASON  AND  THE  RESULT 

1  It  has  been  shown  that,  if  two  countries  buy  of  each  other 
to  the  same  amount,  their  transactions  need  not  give  rise  to 
two  separate  sets  of  bills,  but  that  on  the  contrary,  if  the  for- 
eigner draws  on  us  to  the  full  value  of  his  exports,  the  bills 
so  created  will  be  sent  as  remittances  to  the  exporter  on  this 
side  and  will  pay  him  for  his  sales.  Conversely,  if  the  British 
exporter  draws,  there  is  no  necessity  for  the  other  side  to  do 
so. 

What,  then,  are  the  facts?  Does  the  United  Kingdom, 
generally  speaking,  draw  on  abroad,  or  does  the  foreigner 
take  the  initiative  by  drawing  on  London? 

As  a  matter  of  fact,  both  sides  draw;  but,  as  all  who  are 
acquainted  with  the  customs  of  trade  are  well  aware,  the  bills 
drawn  by  Great  Britain  on  abroad  are  vastly  outnumbered  by 
those  drawn  from  abroad  on  London. 

Owing  chiefly  to  the  magnitude  of  our  trade,  but  also  to 
several  contributory  causes  —  such  as  the  stability  of  our  cur- 
rency; the  certainty  that  a  bill  on  London  means  gold  and 
nothing  but  gold;  the  facility  with  which  those  who  deserve 
credit  can  obtain  it  here;  our  freedom  from  invasion,  etc. — 
London  has  become  to  a  great  extent  the  settling-place  of 

1  George  Clare,  The  A  B  C  of  the  Foreign  Exchanges,  pp.  11-15.  Mac- 
millan  and  Company,  London.  1911. 


324  FOREIGN  EXCHANGE 

Europe  and  the  world,  and  the  seller,  wherever  he  may  be,  of 
a  good  bill  on  London  can  always  be  sure  of  finding  a  buyer 
and  of  realizing  a  fair  price.  As  the  sale  of  a  bill,  moreover, 
carries  the  valuable  advantage  of  ready  money  and  a  speedy 
turnover  of  capital,  it  is  invariably  preferred  by  the  foreign 
exporter,  who  has  consigned  or  sold  produce  to  us,  to  the 
alternative  plan  of  awaiting  remittances  from  this  side.  The 
foreign  importer,  too,  who  has  to  pay  for  the  goods  he  has 
bought,  would  rather  do  so  by  remitting  to  London  than  by 
allowing  us  to  draw  upon  him.  In  the  former  case,  the  rate 
he  has  to  pay  depends  upon  his  own  success  in  higgling;  in 
the  latter,  it  is  fixed  by  a  London  bill-broker,  who  has  not 
the  same  interest  in  the  matter. 

If  the  same  considerations  held  good  on  this  side  also,  our 
merchants  and  manufacturers  might  perhaps  object  to  letting 
the  foreigner  have  it  all  his  own  way ;  but,  on  the  contrary,  it 
appears  to  suit  both  buyers  and  sellers  very  well  —  the  former, 
because  in  the  majority  of  cases  they  would  scarcely  know  how 
or  where  to  buy  suitable  bills,  and  the  latter,  because  the  draw- 
ing and  negotiation  of  a  foreign  bill  requires  a  certain  amount 
of  knowledge  of  the  exchanges,  which  they  do  not  always 
possess,  and  entails  a  certain  amount  of  trouble,  which  they 
would  gladly  be  spared.  There  is  also  more  risk  of  loss  in 
drawing.  In  the  latter  case  they  have  only  their  correspond- 
ent to  look  to,  while  on  a  London  remittance  they  have  the 
additional  security  of  the  other  parties  to  the  bill. 

Practically  speaking,  therefore,  the  settlement  of  our  for- 
eign trade  is  effected  by  means  of  bills  of  exchange  which  are 
drawn  and  negotiated  abroad,  and  are  accepted  and  paid  in 
London. 

To  the  student  of  the  exchanges  this  fact  is  of  considerable 
importance,  for,  as  the  rate  of  exchange  between  two  coun- 
tries —  the  price  at  which  bills  on  the  one  are  sold  in  the  other 
—  must  be  fixed  by  the  one  that  draws  and  negotiates  the  bill, 
it  follows  that  the  exchanges  between  England  and  most  other 
countries  are  controlled  from  the  other  side,  and  that  we  in 
London  have  scarcely  part  or  say  in  the  matter.  The  rate 
of  exchange,  for  example,  between  England  and  the  United 
States  is  fixed  in  New  York;  between  England  and  Brazil, 


ENGLAND  DRAWS  FEW  BILLS  325 

in  Rio ;  between  England  and  Turkey,  in  Constantinople ;  and 
so  on.  There  may  be  exceptions,  of  which  the  Indian  ex- 
change is  the  most  notable,  but  that  is  the  general  rule,  and 
it  is  one  that  should  be  carefully  borne  in  mind. 

The  same  fact  also  supplies  a  reason  for  the  solicitude  with 
which  the  foreign  trader  watches  the  fluctuations  of  the  ex- 
change, and  for  the  utter  indifference  with  which  they  are 
regarded  by  the  British  trader.  To  the  former,  who  intends 
maybe  to  draw  a  few  hundred  pounds  on  'London  in  a  day 
or  two  against  the  shipment  he  is  preparing,  the  difference 
between  selling  his  draft  next  week  instead  of  this  may  mean, 
if  the  rate  should  move  in  his  favor,  the  gain  of  an  addi- 
tional half  per  cent. ;  but  to  our  home  manufacturers,  who  sell 
their  wares  in  sterling  and  stipulate  for  payment  in  bills  on 
London,  the  see-saw  of  rates  is  but  of  academic  interest. 
They  pay  attention  to  the  course  of  discount,  because  they  may 
have  to  melt  some  of  their  paper  before  pay-day  comes  round; 
but  the  course  of  the  exchange  —  the  question  of  the  rate  ris- 
ing or  falling  —  hardly  concerns  them  at  all. 

It  is  not  sought  to  detract  from  the  influence  of  the  English- 
drawn  foreign  bill,  or,  as  might  be  imagined,  to  explain  it 
away  altogether.  On  the  contrary,  paper  to  a  considerable 
amount  is,  and  will  continue  to  be,  negotiated  on  the  Royal 
Exchange  (though  the  total,  if  compared  with  that  of  the 
paper  on  London  negotiated  abroad,  would  appear  quite  in- 
significant).1 The  object  in  view  is  merely  to  bring  into 
prominence,  and  to  impress  on  the  reader,  the  essential  prin- 
ciple that,  while  the  position  of  every  rate  of  exchange  is  the 
outcome  of  the  market  conditions  in  the  two  countries  com- 
bined, the  predominant  mass  of  the  dealings  take  place  on  the 
other  side,  so  that,  as  a  consequence,  the  real  significance  of 
the  fluctuations  can  only  be  grasped  by  viewing  them  from  the 
foreign  [e.  g.,  American]  standpoint. 

1  [English  bills  drawn  on  our  banks  have  increased  in  volume  since  1914, 
through  the  operation  of  the  Federal  Reserve  Act  and  the  amended  New- 
York  State  Bank  Law  which  make  provision  for  the  acceptance  of  time 
drafts  by  National  and  New  York  State  banks,  respectively.] 


326  FOREIGN  EXCHANGE 

THE  RECENT  RISE  OF  THE  AMERICAN  ACCEPTANCE 
MARKET 

1  Probably  the  most  important  effect  at  this  time  [1915]  of 
the  Federal  Reserve  Act  is  the  establishment  of  the  American 
acceptance  market.  It  may  well  be  said  that  heretofore  Amer- 
ica has  had  no  real  money  market.  The  only  semblance  of 
a  money  market  previously  existing  in  this  country  was  the 
call  loan  market  of  New  York  City.  That,  however,  did  not 
truly  reflect  money  conditions  in  this  country,  as  it  has  more 
often  reflected  the  secondary  effect  of  some  movement  of  the 
stock  market. 

The  development  of  a  real  money  market  in  this  country 
was  greatly  hampered  by  the  lack  of  a  standardized  credit 
instrument.  In  every  other  country  the  bank  acceptance  in 
which  the  element  of  credit  risk  has  been  practically  eliminated 
is  the  standard  instrument  of  credit,  and  the  discount  rate  of 
such  paper  marks  the  level  of  the  money  market. 

Bank  acceptances  were  not  known  in  this  country  prior  to 
the  operation  of  the  Federal  Reserve  Act.  For  the  benefit 
of  those  who  may  not  be  familiar  with  bank  acceptances,  I 
will  briefly  describe  an  operation  giving  rise  to  such  accept- 
ances. Jones,  an  importer  of  coffee  in  New  York,  desires  to 
purchase  a  cargo  of  coffee  in  Rio  de  Janeiro.  He  goes  to  his 
bank  in  New  York  and  arranges  with  them  to  finance  the 
deal.  Smith,  the  grower  of  the  coffee  in  Brazil,  makes  the 
shipment  to  New  York  and  draws  a  ninety  days'  sight  draft 
on  the  New  York  bank  for  the  amount  of  his  invoice.  This 
draft  he  then  sells  to  some  Brazilian  bank.  .  .  .  The  Brazilian 
bank  then  sends  the  draft  to  New  York.  It  is  there  presented 
to  the  New  York  bank  for  acceptance.  The  New  York  bank 
accepts  the  draft  by  writing  the  word  "  accepted  "  across  the 
face  of  the  draft  and  affixing  its  official  signature  thereto. 
The  draft  now  becomes  the  primary  obligation  of  the  New 
York  bank.  Of  course,  Jones,  for  whose  account  the  New 
York  bank  accepted  the  draft,  has  obligated  himself  to  provide 

1  John  E.  Rovensky,  How  the  War  Affects  Practical  Operations  in  Inter- 
national Exchange,  Journal  of  the  American  Bankers  Association,  Vol. 
7,  No.  12,  June,  1915,  pp.  1008,  1009. 


DOLLAR  CREDITS  327 

the  New  York  bank  with  funds  to  meet  the  draft,  but  if  he 
should  fail  to  do  so  the  New  York  bank  must  pay  the  accept- 
ance nevertheless.  It  is,  therefore,  the  direct  obligation  of 
the  New  York  bank,  and  as  such  it  commands  the  best  dis- 
count rates  current.  This  briefly  is  what  is  known  as  a  bank 
acceptance,  i.  e.,  a  draft  drawn  on  and  accepted  by  a  prime 
bank  or  banker. 

Although  this  business  is  still  in  its  infancy,  it  has  reached 
important  proportions  and  there  is  an  active  market  for  them 
in  New  York  City.  A  number  of  brokers  have  taken  up  the 
business  of  buying  and  selling  acceptances.  Every  morning 
they  make  the  rounds  of  the  various  banks  with  the  list  of  the 
acceptances  they  have  for  sale  and  the  rates  at  which  they  are 
willing  to  sell  them.  Incidentally,  they  also  learn  whether 
the  banks  have  any  acceptances  for  sale  and  at  what  rates. 
As  the  credit  risk  is  practically  eliminated,  acceptances  are  a 
very  attractive  form  of  secondary  reserve ;  they  are,  as  a  Lon- 
don banker  once  expressed  it,  a  means  of  enabling  the  banker 
to  eat  his  cake  and  have  it  too  —  the  banker  by  investing  his 
money  in  acceptances  earns  the  discount  and  at  the  same  time 
he  knows  that  his  money  is  instantly  available  in  case  of  need, 
so  that  they  are  almost  as  available  as  cash.  This  explains 
why  the  discount  rate  on  acceptances  ranges  so  low.  Ninety 
days'  sight  acceptances  sold  in  New  York  City  at  one  time 
as  low  as  2  per  cent,  per  annum  and  to-day  prime  acceptances 
command  the  excellent  rate  of  2^  per  cent. 

THE  ECONOMIES  AND  ADVANTAGES  OF  "  DOLLAR 
CREDITS  "  l 

Many  radical  changes  in  the  mechanism  of  international 
finance  have  occurred  during  the  past  fifteen  months,  since  the 
beginning  of  the  European  war.  Not  the  least  important 
among  these  changes,  viewed  from  the  standpoint  of  the  Amer- 
ican importer,  is  the  evolution  in  the  methods  of  financing  our 
importations. 

Our  imports  in  the  way  of  commodities  such  as  hides,  coffee, 

1  Joseph  T.  Cosby,  The  Economies  and  Advantages  of  "Dollar  Credits." 
The  National  City  Bank,  New  York.     1915. 


328  FOREIGN  EXCHANGE 

rubber,  wool,  etc.,  etc.,  run  into  hundreds  of  millions  of  dol- 
lars annually,  and  these  are  financed  generally  through  the 
medium  of  commercial  credits  established  by  the  purchaser 
in  favor  of  the  vendor  of  the  merchandise.  Commercial 
credits,  so  called,  are  in  effect  a  bank  guarantee  to  the  seller 
that  his  drafts  covering  certain  merchandise,  when  drawn  in 
accordance  with  the  conditions  prescribed  in  the  credit,  will 
meet  with  due  honor  on  presentation  to  the  accepting  bank 

named  in  the  credit  instrument. 

» 

In  order  merely  to  gain  an  idea  as  to  the  importance  and 
volume  of  such  transactions,  it  is  only  necessary  to  glance  at 
the  totals  of  a  few  of  our  principal  imports.  In  the  year  1914 
we  imported,  among  other  commodities,  the  following: 

Hides  and  skins  $120,289,781.00 

Coffee    1 10,725,392.00 

Rubber    131,995,742.00 

Wool    (unmanufactured)    53,190,767.00 

Prior  to  the  outbreak  of  the  war  in  Europe,  it  is  safe  to 
assume  that  fully  95  per  cent,  of  the  credits  issued  to  cover 
these  importations  were  passed  through  London  in  the  form 
of  sterling  credits;  that  is  to  say,  credits  available  by  drafts 
drawn  in  pounds  sterling  on  London.  Requests  for  the  issu- 
ance of  credits  available  by  drafts  drawn  in  United  States 
dollars  on  New  York  were  extremely  rare,  and  they  were 
issued  only  in  exceptional  cases. 

Conditions  have  changed  materially  in  this  respect.  The 
Federal  Reserve  Act  grants  to  national  banks  the  privilege 
of  accepting  drafts  or  bills  of  exchange  growing  out  of  trans- 
actions involving  the  importation  or  exportation  of  goods. 
This  acceptance  privilege  was  accorded  to  national  banks  only 
a  short  time  before  the  commencement  of  hostilities  abroad, 
and  this  fact  in  conjunction  with  the  resulting  dislocation  in 
the  delicate  machinery  of  international  credit  brought  about 
by  the  war,  together  with  the  coincidental  establishment  of 
American  branch  banks  in  South  America,  has  contributed  in 
a  large  measure  to  bring  about  the  use  of  what  is  known  now 
as  "  Dollar  Credits." 

As  a  factor  in  creating  the  existing  demand  for  Dollar 
Credits,  the  establishment  of  American  branch  banks  abroad 


DOLLAR  CREDITS  329 

cannot  be  emphasized  too  strongly.  Through  these  branch 
banks,  a  new  and  adequate  medium  for  the  liquidation  of 
transactions  as  between  the  United  States  and  certain  South 
American  countries,  especially  the  Argentine,  Brazil,  and  Uru- 
guay, has  been  placed  at  the  disposal  of  our  merchants.  A 
direct  channel  is  now  open  to  the  ebb  and  flow  of  credit  trans- 
fer between  the  United  States  and  the  countries  mentioned, 
and,  as  a  natural  sequence,  the  former  disparity  existing 
against  the  dollar,  as  compared  with  pounds  sterling  and  the 
principal  continental  exchanges,  has  disappeared.  The  result- 
ing equalization  in  the  rates  of  exchange  benefits  the  American 
merchant  to  the  extent  of  relieving  him  of  the  tribute  formerly 
paid  to  the  indirect  channels  of  liquidation,  or,  in  other  words, 
to  the  foreign  banker. 

The  Dollar  Credit  is  of  capital  importance  to  every  Amer- 
ican merchant  w;ho  is  interested  either  directly  or  indirectly  in 
the  importation  of  commodities  of  any  character.  A  study  of 
the  advantages  accruing  from  this  form  of  credit  will  demon- 
strate the  desirability  of  its  general  employment  as  the  vehicle 
for  financing  not  only  our  own  imports  but  also  those  of  other 
countries.  Primarily,  it  is  more  economical  than  the  Sterling 
or  Continental  Credit,  for  the  initial  commission  cost  of  issu- 
ance is  lower.  Secondly,  it  is  based  on  a  known  quantity, 
the  dollar,  a  factor  of  supreme  importance  in  these  days  of 
extreme  and  violent  fluctuations  in  the  exchange  rates,  and 
therefore  all  exchange  risk  is  eliminated  from  the  operation 
as  far  as  the  importer  is  concerned.  Maturities  drawn  under 
Dollar  Credits  are  due  and  payable  in  dollars  on  a  given  date, 
and  no  question  arises  as  to  what  the  exchange  rate  on  London 
may  be  ninety  days  after  acceptance  of  the  bill. 

Under  existing  conditions  in  the  New  York  money  market, 
and  considering  the  present  low  rates  of  interest  actually  in 
effect,  the  use  of  Dollar  Credits  is  proving  to  be  particularly 
attractive  to  the  American  importer  as  the  medium  for  finan- 
cing his  importations.  The  rate  of  discount  in  New  York 
for  prime  bank  acceptances  is  2%@2%  per  cent,  per  annum, 
and  a  broad,  well-developed  discount  market  now  exists,  with 
an  ever-increasing  demand  in  evidence  for  this  class  of  paper. 
On  the  other  hand,  the  rate  of  discount  in  London  for  prime 


330  FOREIGN  EXCHANGE 

ninety-day  bills  is  4)4  per  cent,  per  annum,  with  operations 
restricted  in  a  far  from  normal  market.  A  comparison  of 
these  two  discount  rates  will  show  a  difference  in  favor  of 
New  York  of  2^/2 @2y$  per  cent,  per  annum.  In  addition  to 
this  difference  in  interest,  there  is  also  a  difference  in  the 
initial  cost  in  the  form  of  commission  for  issuance,  as  between 
credits  available  by  ninety-day  drafts  drawn  on  New  York 
in  dollars  and  those  available  by  ninety-day  drafts  drawn  on 
London  in  pounds  sterling.  This  difference  in  commission 
in  favor  of  New  York  will  average  ^2  per  cent,  per  annum, 
and  when  added  to  the  saving  in  discount  or  interest  already 
noted,  will  show  a  net  saving  on  the  Dollar  Credit  of  3@3^ 
per  cent,  per  annum,  which  accrues  to  the  importer  through 
the  use  of  Dollar  Credits  in  his  operations. 

Quite  apart  from  the  direct  economy  to  the  individual  re- 
sulting from  the  use  of  Dollar  Credits,  is  the  broader  question 
of  the  economic  value  accruing  to  the  nation  as  a  whole 
through  the  designation  of  the  dollar  as  the  basis  of  value  in 
our  credit  transactions  with  the  rest  of  the  world.  Since 
1903,  when  the  total  of  our  imports  amounted  to  $1,025,719,- 
237,  the  volume  of  our  imports  has  increased  rapidly,  and  in 
1914,  the  total  imports  reached  the  enormous  sum  of  $1,893,- 
925,657.  These  figures  cover  products  from  all  parts  of  the 
world  shipped  direct  to  our  own  shores,  and  while  no  nation 
enjoys  higher  international  credit  than  the  United  States,  yet 
it  is  a  fact  that  in  order  to  finance  the  movement  of  our  im- 
ports we  have  been  compelled  to  have  recourse  to  indirect 
channels  and  call  on  foreign  money  centers  to  furnish  us  with 
the  necessary  credit  facilities  to  take  care  of  a  large  part  of 
our  importations.  Naturally,  we  have  been  obliged  to  pay 
for  this  accommodation,  and  the  service  has  cost  us  millions 
of  dollars  annually  in  interest,  commissions,  etc. 

These  charges  can  be  saved  and  an  important  economy  ef- 
fected, thus  benefiting  our  commerce  as  a  whole  by  the  gen- 
eral designation  of  dollars  in  our  foreign  credit  transactions. 
The  purchasing  power  of  the  dollar  in  foreign  markets  is 
much  greater  to-day  than  it  is  in  normal  times  because  of  the 
varying  premium  which  the  dollar  commands  at  present  prac- 
tically throughout  the  world.  The  time  is  unquestionably  op- 


NEW  YORK  MARKET  331 

portune  to  increase  the  prestige  of  the  dollar  and  to  standard- 
ize its  use  in  the  liquidation  of  our  direct  purchases  abroad. 
Co-operation  and  concerted  action  on  the  part  of  our  merchants 
to  the  end  of  generalizing  the  use  of  Dollar  Credits  is  there- 
fore a  duty,  which  will  bring  about  lasting  benefit  to  the  eco- 
nomic fabric  of  our  commerce. 


THE  NEW  YORK  FOREIGN  EXCHANGE  MARKET  1 

A  market  may  be  defined  as  the  coming  together  of  buyers 
and  sellers.  It  therefore  involves  all  the  mechanism  neces- 
sary to  facilitate  their  intercourse.  One  may  speak  of  a  gen- 
eral market  or  of  a  local  market,  of  a  market  in  one  or  in 
another  place.  Thus,  there  is  the  New  York  market  for  the 
buying  and  selling  of  exchange  on  London.  A  bank  in  New 
Haven,  Connecticut,  may  be  a  part  of  that  market  if  it  buys 
from  and  sells  to  it.  That  market  includes,  besides  the  com- 
mercial and  industrial  organizations  which  buy  or  sell  drafts, 
all  middlemen  of  whatever  class  who  engage  in  the  trade. 

The  middlemen  may  be  divided  roughly  into  three  classes. 
First  may  be  mentioned  banks  which  do  a  regular  foreign  ex- 
change business,  buying  bills  from  those  who  have  them  to  sell 
and  selling  their  own  drafts  on  foreign  correspondents  to  per- 
sons desiring  to  remit.  Much  of  this  business  is  done  by  for- 
eign exchange  banks  which  carry  on  little  or  no  other  business. 
vSome  of  it  is  done  by  ordinary  commercial  banks,  such  as 
United  States  National  Banks,  in  addition  to  their  other  bank- 
ing business.  Second,  we  may  call  attention  to  those  exchange 
dealers  whose  principal  business  is  to  buy  commercial  and 
bankers'  bills,  and  to  resell  them,  chiefly  to  banks.  Third  are 
the  independent  brokers  who  make  small  commissions  by 
bringing  buyers  and  sellers  together.  These  do  not  invest 
their  own  capital,  do  not,  that  is,  buy  bills  of  exchange  in  the 
market,  but  assist  those  desiring  to  sell  bills  to  find  buyers, 
and  vice  versa.  .  .  . 

1  Harry  G.  Brown,  International  Trade  and  Exchange,  pp.  65-66.  The 
Macmillan  Company.  New  York.  1914. 


332  FOREIGN  EXCHANGE 

NEW  YORK  CITY  PRACTICALLY  ABSORBS  BY  PURCHASE 
ALL  AMERICAN  FOREIGN  EXCHANGE 

1  There  is,  perhaps,  no  feature  pertaining  to  banking 
throughout  the  country  so  dependent  upon  New  York  finan- 
ciers, as  foreign  exchange.  The  very  foundation  of  this 
branch  of  banking  is  constructed  by  the  New  York  bankers, 
and  from  their  banking  houses  emanate  the  basic  prices  and 
quotations  upon  which  foreign  bills  are  bought  and  sold 
throughout  the  United  States. 

It  is  the  custom  of  New  York  foreign  exchange  brokers  to 
furnish  their  Western  clients,  direct,  or  through  their  local 
representatives,  daily  market  quotations,  and  to  promptly  ad- 
vise them  of  fluctuations  throughout  the  day.  So  closely  is  the 
West  allied  to  the  East,  in  this  respect,  that  any  interruption 
caused  by  delayed  or  suspended  telegraphic  service,  immedi- 
ately superinduces  a  practical  standstill  of  exchange  transac- 
tions, and  operations  thereafter  must  necessarily  be  made  in 
the  "  dark  "  until  free  communication  is  again  renewed  be- 
tween the  cities.  .  .  . 

The  absorptive  power  of  the  New  York  market,  to  digest 
not  only  the  surplus  foreign  exchange  of  the  Chicago  market, 
but  that  of  the  entire  United  States  as  well,  has  been  demon- 
strated for  many  years.  The  reason  for  this  can  be  attributed 
to  the  fact  that  international  trade  balances  are  at  the  pres- 
ent day,  and  always  will  be,  adjusted  by  the  financiers  of  New 
York  City. 

How  MONEY  Is  MADE  IN  FOREIGN  EXCHANGE  —  THE 
OPERATIONS  OF  THE  FOREIGN  DEPARTMENT 

*  Complete  description  of  the  various  forms  of  activity  of  the 
foreign  exchange  department  of  an  important  firm  would  fill 
a  large  volume,  but  there  are  certain  stock  operations  in  for- 
eign exchange  which  are  the  basis  of  most  of  the  transactions 
carried  out  and  the  understanding  of  which  ought  to  go  a  long 

1  Anthony  W.  Margraff,  International  Exchange,  pp.   104-105.    Fergus 
Printing  Company,  Chicago.     1903. 

2  Adapted   from  Franklin  Escher,  Elements  of  Foreign  Exchange,  pp. 
68-101.    Bankers  Publishing  Company.     1910. 


OPERATIONS  OF  FOREIGN  DEPARTMENT  333 

way  toward  making  clear  what  the  nature  of  the  foreign  ex- 
change department's  business  really  is. 

I.    SELLING   "  DEMAND  "   AGAINST    "  DEMAND  " 

The  first  and  most  elementary  form  of  activity  is,  of  course, 
the  buying  of  demand  bills  at  a  certain  price  and  the  selling 
of  the  banker's  own  demand  drafts  against  them  at  a  higher 
price.  A  banker  finds,  for  instance,  that  he  can  buy  John 
Smith  &  Co.'s  sight  draft  for  £1,000,  on  London,  at  the  rate 
of  4.86,  and  that  he  can  sell  his  own  draft  for  f  1,000  on  his 
London  banking  correspondent  at  4.87.  All  he  has  to  do, 
therefore,  is  to  buy  John  Smith's  draft  for  $4,860,  send  it  to 
London  for  credit  of  his  account  there,  and  then  draw  his  own 
draft  for  £1,000  on  the  newly  created  balance,  selling  it  for 
$4,870.  It  cost  him  $4,860  to  buy  the  commercial  draft,  and 
he  has  sold  his  own  draft  against  it  for  $4,870.  His  gross 
profit  on  the  transaction,  therefore,  is  $10. 

As  may  be  imagined,  not  very  much  money  is  made  in 
transactions  exactly  of  this  kind  —  the  one  cited  is  taken  only 
because  it  illustrates  the  principle.  For  whether  the  banker 
sends  over  in  every  mail  a  bewildering  assortment  of  every 
conceivable  form  of  foreign  exchange  to  be  credited  to  his 
account  abroad,  or  whether  he  confines  himself  to  remittances 
of  the  simplest  kind  of  bills,  the  idea  remains  exactly  the 
same  —  he  is  depositing  money  to  the  credit  of  his  account 
in  order  that  he  may  have  a  balance  on  which  he  can  draw. 
That  is,  indeed,  the  sum  and  substance  of  the  exchange  busi- 
ness of  the  foreign  department  of  most  banking  houses  —  the 
maintaining  of  deposit  accounts  in  banks  at  foreign  centres  on 
which  deposit  account  the  bank  here  is  in  a  position  to  draw 
according  to  the  wants  and  needs  of  its  customers. 

II.    SELLING    CABLES   AGAINST   DEMAND    EXCHANGE 

A  "  cable,"  so-called,  differs  from  a  sight  draft  only  in  that 
the  banker  abroad  who  is  to  pay  out  the  money  is  advised  to 
do  so  by  means  of  a  telegraphic  message  instead  of  by  a  bit 
of  paper  instructing  him  to  "  pay  to  the  order  of  so  and  so." 

Under  ordinary  circumstances  foreign  exchange  dealers  who 
engage  in  the  business  of  selling  cables  carry  adequate  balances 


334  FOREIGN  EXCHANGE 

on  the  other  side,  balances  which  they  keep  replenishing  by 
continuous  remittances  of  demand  exchange. 

III.    SELLING    "  DEMAND  "    BILLS   AGAINST    REMITTANCES    OF 

LONG    BILLS 

If  there  is  a  stock  operation  in  the  conduct  of  a  foreign  ex- 
change business  it  is  the  selling  by  bankers  of  their  demand 
bills  of  exchange  against  remittances  of  commercial  and  bank- 
ers' long  paper.  Bills  of  the  latter  class  make  up  the  bulk  of 
foreign  exchange  traded  in,  and  its  disposal  naturally  is  the 
most  important  phase  of  foreign  exchange  business.  What 
the  foreign  exchange  business  really  is  grounded  on  is  the 
existence  of  commercial  bills  called  into  existence  by  exports 
of  merchandise. 

Buying  and  remitting  commercial  long  bills  is  no  pastime 
for  an  inexperienced  man.  Entirely  aside  from  the  question 
of  rate,  and  profit  on  the  exchange  end  of  the  transaction, 
there  must  be  taken  into  consideration  the  matter  of  the  credit 
of  the  drawer  and  the  drawee,  the  salability  of  the  merchan- 
dise specified  in  the  bill  of  lading,  and  a  number  of  other  im- 
portant points. 

Where  documents  accompany  the  draft  and  the  merchandise 
is  formally  hypothecated  to  the  buyer  of  the  draft,  it  might 
not  be  thought  that  the  standing  of  the  drawer  would  be  of 
such  great  importance.  Possession  of  the  merchandise,  it  is 
true,  gives  the  banker  a  certain  form  of  security  in  case  accept- 
ance of  the  bill  is  refused  by  the  parties  on  whom  it  is  drawn 
or  in  case  they  refuse  to  pay  it  when  it  comes  due,  but  the 
disposal  of  such  collateral  is  a  burdensome  and  often  expensive 
operation.  The  banker  in  New  York  who  buys  a  sixty-day 
draft  drawn  against  a  shipment  of  butter  is  presumably  not 
an  expert  on  the  butter  market  and  if  he  should  be  forced  to 
sell  the  butter,  might  not  be  able  to  do  so  to  the  fullest  possi- 
ble advantage.  Employment  of  an  expert  agent  is  an  ex- 
pensive operation,  and,  moreover,  there  is  always  the  danger 
of  legal  complication  arising  out  of  the  banker's  having  sold 
the  collateral.  It  is  desirable  in  every  way  that  if  there  is  to 
be  any  trouble  about  the  acceptance  or  payment  of  a  draft,  the 
banker  should  keep  himself  out  of  it. 


OPERATIONS  OF  FOREIGN  DEPARTMENT  335 

The  successive  steps  in  an  actual  transaction  are  as  fol- 
lows : 

The  banker  in  New  York  having  ascertained  by  cable  the 
rate  at  which  bills  "  to  arrive  "  in  London  by  a  certain  steamer 
will  be  discounted,  buys  the  bills  here  and  sends  them  over, 
with  instructions  that  they  be  immediately  discounted  and  the 
proceeds  placed  to  his  credit.  On  this  resulting  balance  he 
will  at  once  draw  his  demand  draft  and  sell  it  in  the  open  mar- 
ket. If,  from  selling  this  demand  draft,  he  can  realize  more 
dollars  than  it  cost  him  in  dollars  to  put  the  balance  over  there, 
he  has  made  a  gross  profit  of  the  difference. 

To  illustrate  more  specifically :  A  banker  has  bought,  say,  a 
£1,000  ninety  days'  sight  prime  draft,  on  London,  documents 
deliverable  on  acceptance.  This  he  has  remitted  to  his  foreign 
correspondent,  and  his  foreign  correspondent  has  had  it 
stamped  with  the  required  "  bill-stamp,"  has  had  it  discounted, 
and  after  having  taken  his  commission  out  of  the  proceeds, 
has  had  them  placed  to  the  credit  of  the  American  bank.  In 
all  this  process  the  bill  has  lost  weight  It  arrived  in  London 
as  f  i ,000,  but  after  commissions,  bill-stamps,  and  ninety-three 
days'  discount  have  been  taken  out  of  it,  the  amount  is  re- 
duced well  below  £  1,000.  The  net  proceeds  going  to  make 
up  the  balance  on  which  the  American  banker  can  draw  his 
draft  are,  perhaps,  not  over  £990.  He  paid  so-and-so  many 
dollars  for  the  £1,000  ninety-day  bill,  originally.  If  he  can 
realize  that  many  dollars  by  selling  a  demand  draft  for  £990 
he  is  even  on  the  transaction. 

IV.    THE   OPERATION   OF   MAKING   FOREIGN    LOANS 

In  its  influence  upon  the  other  markets,  there  is  perhaps  no 
more  important  phase  of  foreign  exchange  than  the  making 
of  foreign  loans  in  the  American  market.  The  mechanics  of 
these  foreign  loaning  operations,  the  way  in  which  the  money 
is  transferred  to  this  side,  etc.,  will  now  be  taken  up. 

To  begin  at  the  very  beginning,  consider  how  favorable  a 
field  is  the  American  market  for  the  employment  of  Europe's 
spare  banking  capital.  Almost  invariably  loaning  rates  in 
New  York  are  higher  than  they  are  in  London  or  Paris.  This 
is  due,  perhaps,  to  the  fact  that  industry  here  runs  on  at  a 


336  FOREIGN  EXCHANGE 

much  faster  pace  than  in  England  or  France,  or  it  may  be  due 
to  the  fact  that  we  are  a  newer  country,  that  there  is  no  such 
accumulated  fund  of  capital  here  as  there  is  abroad.  Such  a 
hypothesis  for  our  own  higher  interest  rates  would  seem  to 
be  supported  by  the  fact  that  in  Germany,  too,  interest  is  con- 
sistently on  a  higher  level  than  in  London  or  Paris,  Germany, 
like  ourselves,  being  a  vigorous  industrial  nation  without  any 
very  great  accumulated  fund  of  capital  saved  by  the  people. 
But  whatever  the  reason,  the  fact  remains  that  in  New  York 
money  rates  are  generally  on  so  much  more  attractive  a  basis 
than  they  are  abroad  that  there  is  practically  never  a  time 
when  there  are  not  hundreds  of  millions  of  dollars  of  English 
and  French  money  loaned  out  in  this  market.  All  through 
the  past  ten  years  London  has  at  various  times  opened  her 
reservoirs  of  capital  and  literally  poured  money  into  the  Ameri- 
can market. 

To  take  up  the  actual  operation  of  loaning  foreign  money 
in  the  American  market,  suppose  conditions  to  be  such  that 
an  English  bank's  managers  have  made  up  their  minds  to  loan 
out  £100,000  in  New  York  —  not  on  joint  account  with  the 
American  correspondent,  as  is  often  done,  but  entirely  inde- 
pendently. Included  in  the  arrangements  for  the  transaction 
will  be  a  stipulation  as  to  whether  the  foreign  bank  loaning 
the  money  wants  to  loan  it  on  the  basis  of  receiving  a  com- 
mission and  letting  the  borrower  take  the  risk  of  how  demand 
exchange  may  fluctuate  during  the  life  of  the  loan,  or  whether 
the  lender  prefers  to  lend  at  a  fixed  rate  of  interest,  say  6  per 
cent.,  and  himself  accept  the  risk  of  exchange. 

What  the  foregoing  means  will  perhaps  become  more  clear 
if  it  is  realized  that  in  the  first  case  the  American  agent  of  the 
foreign  lender  draws  a  ninety  days'  sight  sterling  bill  for,  say, 
£100,000  on  the  lender,  and  hands  the  actual  bill  over  to  the 
parties  here  who  want  the  money.  Upon  the  latter  falls  the 
task  of  selling  the  bill,  and,  ninety  days  later,  when  the  time 
of  repayment  comes,  the  duty  of  returning  a  demand  bill  for 
£100,000,  plus  the  stipulated  commission.  In  the  second  kind 
of  a  loan  the  borrower  has  nothing  to  do  with  the  exchange 
part  of  the  transaction,  the  American  banking  agent  of  the 
foreign  lender  turning  over  to  the  borrower  not  a  sterling 


OPERATIONS  OF  FOREIGN  DEPARTMENT  337 

draft  but  the  dollar  proceeds  of  a  sterling  draft.  How  the  ex- 
change market  fluctuates  in  the  meantime  —  what  rate  may 
have  to  be  paid  at  the  end  of  ninety  days  for  the  necessary 
demand  draft  —  concerns  the  borrower  not  at  all.  He  re- 
ceived dollars  in  the  first  place,  and  when  the  loan  comes  due 
he  pays  back  dollars,  plus  4,  5,  or  6  per  cent.,  as  the  case  may 
be.  What  rate  has  to  be  paid  for  the  demand  exchange  affects 
the  banker  only,  not  the  borrower. 

Loans  made  under  the  first  conditions  are  known  as  sterling, 
mark,  or  franc  loans ;  the  other  kind  are  usually  called  "  cur- 
rency loans."  At  the  risk  of  repetition,  it  is  to  be  said  that 
in  the  case  of  sterling  loans  the  borrower  pays  a  flat  commis- 
sion and  takes  the  risk  of  what  rate  he  may  have  to  pay  for 
demand  exchange  when  the  loan  comes  due.  In  the  case  of 
a  currency  loan  the  borrower  knows  nothing  about  the  foreign 
exchange  transaction.  He  receives  dollars,  and  pays  them 
back  with  a  fixed  rate  of  interest,  leaving  the  whole  question 
and  risk  of  exchange  to  the  lending  banker. 

To  illustrate  the  mechanism  of  one  of  these  sterling  loans. 
Suppose  the  London  Bank,  Ltd.,  to  have  arranged  with  the 
New  York  Bank  to  have  the  latter  loan  out  £100,000  in  the 
New  York  market.  The  New  York  Bank  draws  £100,000  of 
ninety  days'  sight  bills,  and,  satisfactory  collateral  having  been 
deposited,  turns  them  over  to  the  brokerage  house  of  Smith  & 
Jones,  the  borrowers.  Smith  &  Jones  at  once  sell  the  £100,- 
ooo,  receiving  therefor,  say,  $484,000. 

The  bills  sold  by  Smith  &  Jones  find  their  way  to  London 
by  the  first  steamer,  are  accepted  and  discounted.  Ninety  days 
later  they  will  come  due  and  have  to  be  paid,  and  ten  days 
prior  to  their  maturity  the  New  York  Bank  will  be  expecting 
Smith  &  Jones  to  send  in  a  demand  draft  for  £100,000,  plus 
Y%  per  cent,  commission,  making  £375  additional.  This  £100,- 
375  less  its  commission  for  having  handled  the  loan,  the  New 
York  Bank  will  send  to  London,  where  it  will  arrive  a  couple 
of  days  before  the  £100,000  of  ninety  days'  sight  bills  orig- 
inally drawn  on  the  London  Bank,  Ltd.,  mature. 

What  each  of  the  bankers  concerned  makes  out  of  the 
transaction  is  plain  enough.  As  to  what  Smith  &  Jones' 
ninety-day  loan  cost  them,  in  addition  to  the  flat  ^  per  cent. 


338  FOREIGN  EXCHANGE 

they  had  to  pay,  that  depends  upon  what  they  realize  from  the 
sale  of  the  ninety  days'  sight  bills  in  the  first  place  and  sec- 
ondly on  what  rate  they  had  to  pay  for  the  demand  bill  for 
£100,000.  Exchange  may  have  gone  up  during  the  life  of 
the  loan,  making  the  loan  expensive,  or  it  may  have  gone  down, 
making  the  cost  very  little.  Plainly  stated,  unless  they  secured 
themselves  by  buying  a  "  future  "  for  the  delivery  of  a  £100,- 
ooo  demand  bill  in  ninety  days  at  a  fixed  rate,  Messrs.  Smith 
&  Jones  have  been  making  a  mild  speculation  in  foreign  ex- 
change. 

If  the  same  loan  had  been  made  on  the  other  basis,  the  New 
York  Bank  would  have  turned  over  to  Smith  &  Jones  not  a 
sterling  bill  for  £100,000,  but  the  dollar  proceeds  of  such  a 
bill,  say  a  check  for  $484,000.  At  the  end  of  ninety  days 
Smith  &  Jones  would  have  had  to  pay  back  $484,000,  plus 
ninety  days'  interest  at  6  per  cent.,  $7,260,  all  of  which  cash, 
less  commission,  the  New  York  Bank  would  have  invested  in 
a  demand  bill  of  exchange  and  sent  over  to  the  London  Bank, 
Ltd.  Whatever  more  than  the  £100,000  needed  to  pay  off 
the  maturing  nineties  such  a  demand  draft  amounted  to,  would 
be  the  London  Bank,  Ltd.'s  profit. 

From  all  of  which  it  is  plainly  to  be  seen  that  when  the  Lon- 
don bankers  are  willing  to  lend  money  here  and  figure  that 
the  exchange  market  is  on  the  down  track,  they  will  insist 
upon  doing  their  lending  on  the  "  currency  loan  "  basis  —  tak- 
ing the  risk  of  exchange  themselves.  Conversely,  when  loan- 
ing operations  seem  profitable  but  rates  seem  to  be  on  the 
upturn,  lenders  will  do  their  best  to  put  their  money  out  in 
the  form  of  "  sterling  loans."  Bankers  are  not  always  right 
in  their  views,  by  any  means,  but  as  a  general  principle  it  can 
be  said  that  when  big  amounts  of  foreign  money  offered  in 
this  market  are  all  offered  on  the  "  sterling  loan  "  basis,  a  ris- 
ing exchange  market  is  to  be  expected. 

From  what  has  been  said  about  the  mechanism  of  making 
these  foreign  loans,  it  is  evident  that  no  transfer  of  cash  actu- 
ally takes  place,  and  that  what  really  happens  is  that  the  for- 
eign banking  institution  lends  out  its  credit  instead  of  its  cash. 
For  in  no  case  is  the  lender  required  to  put  up  any  money. 
The  foreign  lender  is  at  no  stage  out  of  any  actual  capital, 


OPERATIONS  OF  FOREIGN  DEPARTMENT  339 

although  it  is  true,  of  course,  that  he  has  obligated  himself  to 
pay  the  drafts  on  maturity,  by  "  accepting  "  them. 

Where,  then,  is  the  limit  of  what  the  foreign  bankers  can 
lend  in  the  New  York  market?  On  one  consideration  only 
does  that  depend  —  the  amount  of  accepted  long  bills  which 
the  London  discount  market  will  stand.  For  all  the  ninety 
days'  sight  bills  drawn  in  the  course  of  these  transfers  of  credit 
must,  eventually  be  discounted  in  the  London  discount  market, 
and  when  the  London  discount  market  refuses  to  absorb  bills 
of  this  kind  a  material  check  is  naturally  administered  to  their 
creation. 

V.    THE   DRAWING   OF    FINANCE-BILLS 

Approaching  the  subject  of  finance-bills,  the  author  is  well 
aware  that  concerning  this  phase  of  the  foreign  exchange 
business  there  is  a  wide  difference  of  opinion.  Finance-bills 
make  money,  but  they  make  trouble,  too.  Their  existence  is 
one  of  the  chief  points  of  contact  between  the  foreign  exchange 
and  the  other  markets,  and  one  of  the  principal  reasons  why  a 
knowledge  of  foreign  exchange  is  necessary  to  any  well- 
rounded  understanding  of  banking  conditions. 

Strictly  speaking,  a  finance-bill  is  a  long  draft  drawn  by  a 
banker  of  one  country  on  a  banker  in  another,  sometimes  se- 
cured by  collateral,  but  more  often  not,  and  issued  by  the 
drawing  banker  for  the  purpose  of  raising  money.  Such  bills 
are  not  always  distinguishable  from  the  bills  a  banker  in  New 
York  may  draw  on  a  banker  in  London  in  the  operation  of 
lending  money  for  him,  but  in  nature  they  are  essentially  dif- 
ferent. Whether  or  not  any  collateral  is  put  up,  the  whole 
purpose  of  the  drawing  of  finance-bills  is  to  provide  an  easy 
way  of  raising  money  without  the  banker  here  having  to  go 
to  some  other  bank  to  do  it. 

The  origin  of  the  ordinary  finance-bill  is  about  a.  follows : 
A  bank  here  in  New  York  carries  a  good  balance  in  London 
and  works  a  substantial  foreign  exchange  business  in  connec- 
tion with  the  London  bank  where  this  balance  is  carried.  A 
time  comes  when  the  New  York  banking  house  could  advan- 
tageously use  more  money.  Arrangements  are  therefore 
made  with  the  London  bank  whereby  the  London  bank  agrees 


340  FOREIGN  EXCHANGE 

to  "  accept "  a  certain  amount  of  the  American  banker's  long 
bills,  for  a  commission.  In  the  course  of  his  regular  business, 
then,  the  American  banker  simply  draws  that  many  more 
pounds  sterling  in  long  bills,  sells  them,  and  for  the  time  being 
has  the  use  of  the  money.  In  the  great  majority  of  cases  no 
extra  collateral  is  put  up,  nor  is  the  London  bank  especially 
secured  in  any  way.  The  American  banker's  credit  is  good 
enough  to  make  the  English  banker  willing,  for  a  commission, 
to  "  accept "  his  drafts  and  obligate  himself  that  the  drafts 
will  be  paid  at  maturity.  Naturally,  a  house  has  to  be  in  good 
standing  and  enjoy  high  credit  not  only  here  but  on  the  other 
side  before  any  reputable  London  bank  can  be  induced  to 
"  accept "  its  finance  paper. 

The  ability  to  draw  finance-bills  of  this  kind  often  puts  a 
house  disposed  to  take  chances  with  the  movement  of  the  ex- 
change market  into  line  for  very  considerable  profit  possibili- 
ties. Suppose,  for  instance,  that  the  manager  of  a  house  here 
figures  that  there  is  going  to  be  a  sharp  break  in  foreign  ex- 
change. He,  therefore,  sells  a  line  of  ninety-day  bills,  putting 
himself  technically  short  of  the  exchange  market  and  banking 
on  the  chance  of  being  able  to  buy  in  his  "  cover  "  cheaply 
when  it  comes  time  for  him  to  cover.  In  the  meantime  he  has 
the  use  of  the  money  he  derived  from  the  sale  of  the  "  nine- 
ties "  to  do  with  as  he  pleases,  and  if  he  has  figured  the  market 
aright,  it  may  not  cost  him  any  more  per  pound  to  buy  his 
"  cover  "  than  he  realized  from  the  sale  of  the  long  bills.  In 
which  case  he  would  have  had  the  use  of  the  money  for  the 
whole  three  months  practically  free  of  interest. 

It  is  plain  speculating  in  exchange  —  there  is  no  getting 
away  from  it,  and  yet  this  practice  of  selling  finance-bills  gives 
such  an  opportunity  to  the  exchange  manager  shrewd  enough 
to  read  the  situation  aright  to  make  money,  that  many  of  the 
big  houses  go  in  for  it  to  a  large  extent.  During  the  summer, 
for  instance,  if  the  outlook  is  for  big  crops,  the  situation  is 
apt  to  commend  itself  to  this  kind  of  operation.  Money  in  the 
summer  months  is  apt  to  be  low  and  exchange  high,  affording 
a  good  basis  on  which  to  sell  exchange.  Then,  if  the  expected 
crops  materialize,  large  amounts  of  exchange  drawn  against 
exports  will  come  into  the  market,  forcing  down  rates  and  giv- 


OPERATIONS  OF  FOREIGN  DEPARTMENT  341 

ing  the  operator  \vho  has  previously  sold  his  long  bills  an  ex- 
cellent chance  to  cover  them  profitably  as  they  come  due. 

VI.    ARBITRAGING    IN   EXCHANGE. 

Arbitraging  in  exchange  —  the  buying  by  a  New  York 
banker,  for  instance,  through  the  medium  of  the  London  mar- 
ket, of  exchange  drawn  on  Paris  —  is  another  broad  and  profit- 
able field  for  the  operations  of  the  expert  foreign  exchange 
manager.  Take,  for  example,  a  time  when  exchange  on  Paris 
is  more  plentiful  in  London  than  in  New  York  —  a  shrewd 
New  York  exchange  manager  needing  a  draft  on  Paris  might 
well  secure  it  in  London  rather  than  in  his  home  city. 

Between  such  cities  rates  are  not  apt  to  be  wide  enough 
apart  to  afford  a  wide  margin  of  profit,  but  the  chance  for 
arbitraging  does  exist  and  is  being  continuously  taken  advan- 
tage of.  So  keenly,  indeed,  are  the  various  rates  in  their 
possible  relation  to  one  another  watched  by  the  exchange  men 
that  it  is  next  to  impossible  for  them  to  "  open  up  "  to  any 
appreciable  extent.  The  chance  to  make  even  a  slight  profit 
by  shifting  balances  is  so  quickly  availed  of  that  in  the  con- 
stant demand  for  exchange  wherever  any  relative  weakness  is 
shown,  there  exists  a  force  which  keeps  the  whole  structure  at 
parity.  The  ability  to  buy  drafts  on  Paris  relatively  much 
cheaper  at  London  than  at  New  York,  for  instance,  would  be 
so  quickly  taken  advantage  of  by  half  a  dozen  watchful  ex- 
change men  that  the  London  rate  on  Paris  would  quickly 
enough  be  driven  up  to  its  right  relative  position.  If  a  chance 
exists  to  sell  a  draft  on  London  and  then  to  put  the  requisite 
balance  there  through  an  arbitration  involving  Paris,  Brussels, 
and  Amsterdam,  the  chances  are  that  there  will  be  some  shrewd 
manager  who  will  find  it  out  and  put  through  the  transaction. 
Some  of  the  larger  banking  houses  employ  men  who  do  little 
but  look  for  just  such  opportunities. 

The  foregoing  are  the  main  forms  of  activity  of  the  average 
foreign  department,  though  there  are,  of  course,  many  other 
ways  of  making  money  out  of  foreign  exchange. 


342  FOREIGN  EXCHANGE 

GOLD  MOVEMENTS 

1  When  there  is  a  heavy  demand  for  exchange  and  little 
supply,  the  price  of  exchange  gradually  advances.  The 
banker,  called  on  by  his  customers  to  draw  exchange  for  them, 
finding  few  bills  in  the  market  that  he  can  remit  to  cover  his 
drafts,  sends  gold  and  directs  its  equivalent  in  foreign  coin  to 
be  placed  to  his  credit,  and  against  this  credit  he  draws.  There 
may  be  no  market  abroad  for  our  crops  or  manufactures;  but 
gold  need  not  be  sold  in  order  to  produce  money ;  it  need  only 
be  coined.  As  this  process  can  be  carried  on  indefinitely,  the 
cost  of  sending  gold  is  obviously  the  limit  beyond  which  the 
price  of  demand  bills  cannot  advance.  Let  us  follow  this 
transaction  in  detail.  The  pure  gold  contained  in  one  English 
sovereign  is  exactly  equal  to  the  pure  gold  contained  in  $4.8665 
of  our  gold  coins;  so  that,  apart  from  charge's  and  expenses, 
$4.8665  of  our  gold  will,  when  sent  abroad,  produce  a  credit 
of  f  i ;  to  this  cost  must  be  added  freight,  insurance,  and  other 
expenses,  amounting  to  about  one-fourth  of  i  per  cent.  This 
brings  the  cost  of  £i  through  shipment  of  gold  to  about  $4.88, 
which  is,  roughly,  the  gold  export  point  for  full  weight  coin. 
The  exporting  banker  obtains  his  gold  either  by  drawing  gold 
coin  from  his  bank  or  else  by  drawing  suitable  currency  from 
his  bank,  and  obtaining  gold  coin  for  it  at  the  subtreasury. 
In  either  case,  he  obtains  coin  that  has  suffered  more  or  less 
abrasion  by  handling,  and  this  loss  of  weight  by  abrasion, 
amounting  to  perhaps  one-tenth  of  I  per  cent,  increases  the 
cost  of  his  remittance.  Generally,  however,  the  banker  can 
obtain  gold  bars  from  the  United  States  Assay  Office  at  the 
nominal  charge  of  one  twenty-fifth  of  i  per  cent.,  although  at 
times  a  larger  charge  is  made.  The  banker  prefers  bars,  be- 
cause on  these  there  is  no  loss  by  abrasion;  the  Government 
can  afford  to  give  bars,  because  their  export  prevents  the  ex- 
port of  coin,  and  so  saves  the  cost  of  coining  new  money  to 
replace  that  shipped. 

Now  for  gold  import.     When  there  is  a  large  volume  of 

1  Albert  Strauss,  Gold  Movements  and  the  Foreign  Exchanges,  The 
Currency  Problem  and  the  Present  Financial  Situation,  A  Series  of  Ad- 
dresses Delivered  at  Columbia  University,  1907-1908,  pp.  65-72.  The 
Columbia  University  Press.  1908. 


GOLD  MOVEMENTS  343 

bills  offered  to  bankers,  perhaps  by  grain  and  cotton  exporters, 
and  but  little  demand  from  buyers  of  exchange,  the  market 
gradually  declines  in  price,  while  New  York  bankers,  sending 
abroad  the  bills  they  buy,  with  little  occasion  to  draw  against 
them,  accumulate  large  sums  to  their  credit  in  London,  with 
no  way  of  getting  the  money  back  to  New  York  through  opera- 
tions in  the  exchange  market.  They  are  not,  however,  help- 
less ;  they  can  order  gold  sovereigns  sent  here,  and,  once  here, 
can  have  them  melted  down  at  the  United  States  Assay  Office 
and  coined  into  eagles  and  double  eagles,  which  they  can  de- 
posit with  their  banks.  Obviously,  the  amount  received  in 
dollars  for  each  melted  sovereign  will  mark  the  price  the 
banker  can  afford  to  pay  for  sterling  bills,  and  competition 
among  bankers  will  prevent  the  rate  of  exchange  from  declin- 
ing below  this  point  by  more  than  a  fair  margin  of  profit.  The 
British  sovereign,  if  full  weight,  will,  when  sent  here  and 
melted  down,  yield  gold  for  which  the  United  States  Assay 
Office  will  pay  $4.8665 ;  the  expense  of  sending  the  sovereign, 
freight,  insurance,  cartage,  and  kegs,  will  amount  to  about 
one  quarter  of  i  per  cent.,  so  that  the  net  yield  of  the  full 
weight  sovereign  in  dollars  will  be  $4.85^.  But  between  the 
day  on  which  the  banker  buys  the  bill  of  exchange  in  New 
York  and  the  day  on  which  he  receives  in  New  York  the  gold 
which  the  bill  entitled  him  to  collect  in  London,  there  must 
elapse  the  time  needed  to  send  the  bill  to  London,  plus  the  time 
needed  to  send  the  gold  back  (roughly  fifteen  days),  during 
which  period  the  banker  loses  the  use  of  the  money.  This 
loss  of  interest  must  be  deducted  from  the  net  yield  of  the 
imported  sovereign,  and  thus,  if  money  is  worth  6  per  cent, 
per  annum,  the  net  yield  of  full  weight  sovereigns  is  brought 
down  to  about  $4.84^4,  which  is  the  gold  import  point  for 
demand  exchange,  when  money  is  worth  6  per  cent,  per  an- 
num. Losses  by  abrasion  will  bring  down  this  point  by  per- 
haps one-tenth  of  i  per  cent,  to  about  $4.83^.  When  money 
is  higher,  the  import  point  will  be  lower,  and  vice  versa. 
There  is  therefore  a  margin  of  profit  in  buying  demand  bills 
and  importing  gold  sovereigns  against  the  purchase,  whenever 
the  rate  for  demand  bills  falls  below  the  gold  import  point. 
Active  exchange  bankers  take  advantage  of  this  profit  when- 


344  FOREIGN  EXCHANGE 

ever  exchange  prices  decline  to  the  proper  point,  and  their 
competition  in  buying  bills  to  cover  their  gold  importations 
stops  further  decline  in  exchange  rates.  It  is  interesting  to 
note  that  during  the  recent  crisis,  when  gold  and  currency  were 
at  a  premium,  bankers  could  sell  the  imported  gold  at  a  pre- 
mium, and  this  constituted  an  additional  and  very  large  profit ; 
gold  importers  could  therefore  pay  higher  prices  than  ordi- 
narily for  exchange  bought  to  cover  the  importations,  and  the 
stress  of  competition  so  drove  up  the  rate  of  exchange  that 
gold  was  being  imported  at  a  profit,  though  exchange  rates 
stood  at  what,  under  ordinary  circumstances,  would  have  been 
the  gold  export  point. 

Gold  is,  however,  not  always  imported  from  England  in 
the  form  of  sovereigns.  The  Bank  of  England  has  in  its 
vaults  large  quantities  of  American  eagles  and  double  eagles 
exported  to  England  in  the  past  and  held  without  melting. 
The  bank  also  holds  foreign  coin  and  bar  gold.  Any  holder 
of  Bank  of  England  notes  can  get  sovereigns  on  demand  — 
other  gold  he  can  get  only  as  the  result  of  a  special  bargain. 
When  gold  is  wanted  for  export,  the  bank  is  often  glad  to  sell 
bar  gold  or  double  eagles  at  rates  somewhat  more  advantage- 
ous to  the  exporter  than  would  be  the  export  of  sovereigns; 
this  the  bank  can  afford  to  do,  for  the  expense  of  coining  sov- 
ereigns to  replace  those  exported  is  thus  saved,  while  the  ex- 
porter, if  he  can  get  bar.  gold  on  the  same  basis  as  sovereigns, 
avoids  the  losses  of  abrasion.  Eagles  are  even  more  advan- 
tageous to  the  exporter,  for  they  are  bought  in  England  by 
weight  and  used  in  America  by  count;  the  banker  therefore 
gets  an  advantage  if  they  are  light,  so  long  as  that  lightness 
is  not  so  great  as  to  make  them  uncurrent  —  practically  he 
buys  them  as  light  and  uses  them  as  full  weight.  .  .  . 

The  mechanism  of  gold  import  to,  and  export  from,  Ger- 
many is  practically  the  same  as  with  England,  the  Reichsbank 
being  required  to  give  gold  coin  in  exchange  for  its  circulating 
notes.  At  times,  however,  German  exchange  has  fallen  below 
the  theoretical  gold  import  point,  owing,  not  to  the  refusal  of 
the  Reichsbank  to  give  gold,  but  to  the  practical  obstacles  that 
at  times  are  somehow  placed  in  the  way  of  free  export  of  gold. 


GOLD  MOVEMENTS  345 

The  Reichsbank  does  not  refuse  gold  for  its  bank-notes,  but 
German  bankers  say  to  their  correspondents :  "  Don't  ask  us 
to  get  gold  for  you,  or  we  shall  lose  caste,"  and  on  such  occa- 
sions German  exchange  rates  drop  to  a  point  that  is  theoret- 
ically impossible.  I  do  not  mean  to  criticise  them:  German 
banks,  when  they  refuse  to  demand  gold  of  the  Reichsbank, 
do  no  more  than  our  own  banks  and  bankers  did  recently,  when 
asked  by  foreign  correspondents  to  collect  in  gold  the  maturing 
obligations  of  railroads  and  other  corporations.  As  will  be 
remembered,  clearing-house  funds  rather  than  cash  were  at 
that  time  current  here,  and  New  York  banks  and  bankers  sent 
to  their  foreign  correspondents  the  same  answer  as  the  Ger- 
mans have  at  times  sent  us.  I  cite  the  German  instance  in 
partial  mitigation  of  censure  of  our  own  course  rather  than 
as  a  reproach  to  them. 

The  Bank  of  France  is  not  compelled  to  give  gold  in  ex- 
change for  its  circulating  notes ;  it  may  at  its  option  give  sil- 
ver. Thus,  when  it  is  inconvenient  to  give  gold,  the  bank  can 
refuse,  or,  if  it  prefers,  it  can  exact  a  premium.  This  power 
has  been  very  moderately  and  very  wisely  used  by  the  bank 
to  modify  foreign  demands  on  the  one  hand,  and,  on  the  other, 
to  keep  interest  rates  low  for  the  requirements  of  internal 
trade.  Of  course,  when  a  premium  is  exacted,  the  French 
gold  import  point  drops  accordingly. 

Between  the  gold  export  point  and  the  gold  import  point, 
exchange  fluctuates  under  the  sway  of  conflicting  currents  and 
tendencies  —  I  had  almost  said  emotions,  for  these  currents 
and  tendencies  have  their  rise  in  emotions,  needs,  and  passions 
as  varied  as  life  itself,  whether  they  be  hunger  as  expressed  in 
the  grain  bill,  or  love  of  elegance  in  the  importation  of  silk,  or 
forethought  in  the  profitable  investment  of  capital. 

This  brief  review  will  have  made  clear  what  is  meant  by  a 
free  gold  market  —  a  market  in  which  current  money  can  at 
all  times  be  exchanged  for  gold  without  delay  and  without 
premium.  Such  a  market  has  great  commercial  advantages; 
its  stability  draws  business  to  it.  London  is  such  a  market, 
and  its  commercial  and  financial  pre-eminence  is  in  great  meas- 
ure due  to  that  fact.  Paris  is  not  such  a  market  and  does  not 


346  FOREIGN  EXCHANGE 

pretend  to  be;  Berlin  pretends  to  be,  but  cannot  always  be 
counted  on;  New  York  was  believed  to  be  before  our  recent 
panic. 

I  have  spoken  of  the  exchange  market  as  an  economical 
mechanism,  automatically  making  delicate  international  adjust- 
ments. In  justification  of  that  observation,  let  me  direct  at- 
tention to  the  manner  in  which  gold,  in  moving  from  financial 
centre  to  financial  centre,  always  travels  by  the  most  direct 
route,  and  that,  too,  not  because  some  public  official  is  charged 
with  the  duty  of  preventing  waste,  but  because  a  private  trader 
is  trying  to  make  a  profit,  and  is  incidentally  serving  the  com- 
munity; serving  it  perhaps  better  than  if  he  had  consciously 
determined  to  serve  it. 

Useful  acts  springing  from  self-interest  have  one  very  com- 
forting aspect  —  we  need  have  no  misgivings  as  to  their  con- 
tinuance. Charity  may  grow  weary  or  disgusted,  but  self- 
interest,  once  enlisted,  may  be  counted  on  to  continue  in  opera- 
tion, whether  it  be  the  business  man's  self-interest  in  a  profit 
or  the  professional  man's  self-interest  in  advancement  and 
fame.  Of  course,  both  the  business  man  and  the  professional 
man,  in  addition  to  seeking  the  direct  rewards  of  their  labor, 
take  an  interest  in  their  work  as  work  and  make  it  yield  them 
pleasure. 

It  is  therefore  satisfactory  to  know  that,  so  long  as  the 
banker  looks  after  his  profits,  gold  will  move  by  the  most 
direct  route.  Let  us  suppose  the  United  States  to  be  export- 
ing a  large  quantity  of  cotton  to  England  at  a  time  when  little 
merchandise  is  being  imported  here  from  England,  but  when 
much  is  being  imported  from  France.  If  the  volume  of  ex- 
ports to  England  and  of  imports  from  France  were  large 
enough,  we  might  conceivably  be  importing  gold  from  Eng- 
land in  payment  of  our  produce,  and  exporting  it  to  France 
in  payment  for  her  luxuries;  but,  in  practice,  gold  does  not 
move  that  way.  Every  morning,  the  New  York  exchange 
banker  learns  by  cable  the  Paris  market  rate  for  demand  bills 
on  London.  When,  therefore,  he  finds  a  large  volume  of  bills 
on  London  offered  for  sale,  and  little  demand  for  such  bills, 
while  there  is  large  demand  for  bills  on  Paris  and  little  supply, 
he  determines,  instead  of  drawing  from  New  York  against  his 


GOLD  MOVEMENTS  347 

purchases  of  'London  bills,  to  let  his  Paris  agent  draw  against 
these  purchases,  placing  the  proceeds  to  his  credit  in  Paris; 
against  this  credit  in  Paris,  the  New  York  banker  draws  his 
bill  in  francs,  having  thus  supplied  via  London  the  New  York 
demand  for  bills  on  Paris.  He  knows  how  many  dollars  each 
pound  sterling  costs  him  in  New  York,  and  the  Paris  rate  for 
bills  on  London  tells  him  how  many  francs  each  pound  sterling 
will  net  him  in  Paris,  and  so  he  can  calculate  how  many  cents 
each  franc  will  cost  him.  Moreover,  he  is  not  the  only  banker 
in  New  York  that  receives  cable  quotations;  and  so  with  a 
large  volume  of  London  bills  offered  and  little  direct  demand 
for  such  bills,  and  large  demand  for  Paris  bills  with  little 
direct  supply,  we  get  a  situation  where  New  York  bankers, 
competing  with  each  other  to  buy  the  London  bills  for  use  via 
Paris,  prevent  the  price  of  sterling  from  falling  to  the  gold 
import  point ;  and  then,  as  a  result,  these  same  bankers,  com- 
peting with  each  other  to  supply  the  demand  for  Paris  bills,  by 
their  competition  prevent  the  Paris  rate  from  rising  to  gold 
export  point.  Lastly,  they  compete  with  each  other  in  Paris, 
where  all  are  sellers  of  bills  on  London  against  their  New 
York  purchases  of  London  bills,  and  by  that  competition  they 
reduce  the  rate  for  London  bills  in  Paris  to  the  point,  at  which, 
other  things  being  equal,  gold  will  go  from  London  to  Paris. 
What  has  happened,  therefore,  is  that  instead  of  our  import- 
ing gold  from  London,  and  then  exporting  it  to  Paris,  it  has 
gone  direct  from  London  to  Paris. 

COMPLICATIONS   IN   THE  DETERMINATION   OF   GOLD   POINTS 

1  It  is  safe  to  assert  that  when  the  exchanges  go  down- to 
the  point  at  which  it  pays  better  to  ship  gold  from  London 
than  to  buy  a  bill,  gold  will  go.  But  in  the  first  place,  experts 
always  differ  as  to  where  that  point  begins ;  and  in  the  second, 
gold  often  leaves  London  long  before  there  is  any  question  of 
its  being  the  more  profitable  form  of  remittance.  In  fact,  it 
may  be  asserted  that  the  foreign  exchanges  very  seldom  go 
down  to  the  export  gold  point,  because  gold  begins  to  go  before 
they  can  get  there. 

1  Hartley  Withers,  Money  Changing,  pp.   159-164.    E.   P.  Button  and 
Company.    New  York.    1914. 


348  FOREIGN  EXCHANGE 

It  has  often  happened  to  me,  when  I  was  a  financial  journal- 
ist and  had  to  try  to  find  out  the  how  and  why  of  gold  move- 
ments, to  ask  several  of  the  most  experienced  and  well-in- 
formed cambists  in  the  city  whether  a  gold  shipment  which 
had  taken  place  had  been  made  as  a  genuine  exchange  transac- 
tion or  was  done  for  some  other  reason,  and  to  hear  from  one 
that  there  was  a  reasonable  exchange  profit  on  it,  from  another 
that  there  might  be  just  a  shade  of  a  turn  to  be  got  out  of  it 
if  you  scraped  it  very  hard  with  a  knife,  and  from  another 
that  you  could  not  find  a  particle  of  profit  in  it  if  you  put  it 
under  a  microscope  for  a  week.  So  many  complications  have 
to  be  considered  that  the  most  eminent  doctors  may  be  par- 
doned for  disagreeing. 

It  may  be  objected  that  dealers  in  exchange,  and  the  com- 
paratively few  firms  that  make  a  special  study  of  gold  ship- 
ping, are  not  in  the  business  for  their  health,  and  that  ship- 
ments would  not  happen  if  there  were  not  some  profit  in 
them.  This  is  perfectly  true,  but  the  profit  need  not  be  got 
from  the  exchange.  As  an  exchange  transaction  it  only  pays 
to  ship  gold  to  America  when  bills  on  London  can  only  be 
sold  in  New  York  at  a  lower  price  than  gold  would  fetch  if 
brought  from  London  and  exchanged  into  dollars  in  New 
York.  If  bills  on  London  are  selling  at  4.83}^,  and  gold  can 
be  bought  and  shipped  and  turned  into  dollars  at  the  rate  of 
4.83^5,  after  allowing  for  all  charges  and  commissions  and 
the  loss  of  interest  during  transit,  then  the  operation  pays  as 
an  exchange  transaction.  If  the  dollars  realized  by  the  gold 
were  at  the  rate  of  only  4.83^  the  importer  would  be  no  better 
off  than  if  he  had  sold  a  bill ;  if  they  were  at  the  rate  of  4.83-)^ 
he  would  be  out  of  pocket  on  the  business,  viewed  strictly  as 
an  exchange  transaction.  But  this  is  by  no  means  the  only 
consideration.  Gold  has  such  a  magical  fascination  for 
moneyed  mankind,  and  its  movements  are  so  eagerly  discussed 
in  their  markets  and  newspapers,  that  it  is  often  handled  and 
shipped  at  a  loss,  especially  in  America,  for  the  sake  of  the 
advertisement  that  the  importing  firm  thereby  gains  for  itself. 

Moreover,  imports  of  gold  have  a  very  stimulating  effect 
on  speculative  stock  markets,  because  an  increase  in  the  amount 
of  gold  available  means  a  roughly  corresponding  increase  in  the 


GOLD  MOVEMENTS  349 

amount  of  credit  that  bankers  can  give,  so  that  when  gold  is 
known  to  be  coming  speculators  know  that  credit  will  be  cheaper 
for  carrying  their  commitments,  and  will  come  in  and  buy,  with 
a  light  heart,  stock  that  they  could  not  possibly  pay  for,  but 
hope  to  pawn  with  their  bankers  until  they  can  sell  it  at  a 
higher  price.  And  so  unless  the  loss  on  the  exchange  side  of 
the  business  is  too  great,  it  often  pays  the  leaders  of  a  bull 
campaign  to  import  gold,  having  first  laid  in  a  line  of  stock, 
and  make  their  profit  by  unloading  during  the  fit  of  exhilara- 
tion produced  by  the  news  that  the  gold  is  on  the  way. 

Or,  again,  quite  apart  from  any  speculative  and  spectacular 
motives  behind  gold  shipments,  it  may  pay  bankers,  in  a  coun- 
try where  rates  for  money  are  ruling  high,  to  import  gold  at 
an  apparent  loss,  because  of  the  high  rates,  that  they  get  for 
the  credit  that  they  are  thereby  enabled  to  give.  They  thus, 
in  effect,  borrow  gold,  and  recoup  themselves  by  being  able  to 
lend,  on  profitable  terms,  larger  amounts  than  they  borrow, 
since  they  can  always  create  credit  to  larger  amounts  than  that 
of  the  gold  in  their  vaults.  Sometimes,  in  fact,  in  times  of 
pressure  banks  find  themselves  obliged  to  import  gold  so  as  to 
strengthen  their  position,  whatever  the  loss  on  exchange 
may  be. 

For  instance,  last  September,  when  the  Berlin  exchange  was 
at  the  point  at  which,  if  theory  ruled  in  these  matters,  Berlin 
ought  to  have  been  thinking  of  packing  up  some  gold  to  send 
to  London,  Berlin  was  buying  gold  in  London  and  shipping  it 
to  the  Fatherland,  because  there  is  always  great  pressure  for 
currency  in  Germany  at  the  end  of  September  when  the  inter- 
est on  mortgages  falls  due  and  has  to  be  paid  in  cash,  with  the 
result  that  the  Reichsbank's  note  circulation  expands  very 
rapidly  and  the  backing  of  gold  behind  it  has  to  be  increased. 
Sometimes,  again,  in  order  to  attract  gold,  a  central  bank  will 
give  importers  credit  for  gold  that  is  on  the  way,  so  that  they 
may  be  saved  from  loss  of  interest  while  the  metal  is  afloat. 
Thus  the  actual  importer  may  make  a  profit  on  the  shipment, 
not  as  a  genuine  exchange  transaction,  but  at  the  expense  of 
the  central  bank. 

In  these  cases  two  of  the  many  functions  performed  by  gold 
have  to  be  considered.  As  a  means  of  international  remit- 


350  FOREIGN  EXCHANGE 

tance,  it  may  not  be  as  cheap  as  a  bill,  but  it  may  have  to  be 
sent,  not  as  a  means  of  remittance,  but  because  it  is  urgently 
wanted  in  the  importing  country  as  a  make-weight  for  the 
balloon  of  credit. 

So  we  see  that  the  grumbling  bill  broker  who  .  .  .  [said] 
that  these  confounded  exchanges  only  work  one  way,  was  actu- 
ally understating  his  case.  Not  only  do  we  [Englishmen] 
always  lose  gold  when  the  exchanges  go  against  us,  and  often 
get  none  when  they  go  in  our  favour,  but  we  also  often  lose 
gold  long  before  the  exchanges  are  sufficiently  against  us  to 
justify  its  going,  and  sometimes  even  when  they  are  strongly 
in  our  favour. 

The  effect  on  the  exchange  of  an  import  or  export  of  gold 
is,  of  course,  just  the  same  as  that  of  the  import  or  export  of 
any  other  commodity  —  an  import  turns  the  exchange  against 
us  and  an  export  turns  it  in  our  favour.  If  we  send  gold,  for 
example,  to  Germany  we  thereby  meet  a  German  claim  on  us 
or  create  a  claim  for  ourselves  on  Germany ;  in  the  former  case 
the  bills  drawn  on  us  will  be  less  by  the  amount  of  the  gold 
shipped,  and  the  supply  in  Berlin  of  bills  on  London  will  be 
less  in  relation  to  the  demand,  so  that  the  tendency  will  be  for 
the  price  of  sovereigns,  as  expressed  in  marks,  to  rise.  In 
the  latter  case  some  one  in  Berlin  will  have  a  claim  to  meet  in 
London  and  will  have  to  bid  there  for  a  bill  on  London,  and 
his  bidding  will  have  the  same  beneficent  effect  on  the  ex- 
change. When  we  import  gold,  whether  brought  out  of  bank- 
ers' vaults,  or  dug  out  of  the  bowels  of  the  earth,  the  country 
that  sends  it  to  us  meets  claims  of  ours  on  it  or  establishes 
claims  on  us.  In  either  case  the  tendency  is  for  the  exchange 
to  move  against  us. 

THE  HANDLING  OF  GOLD  SHIPMENTS 

1  Whether  in  coined  pieces  or  bars  (bullion),  the  gold  is 
packed  in  strong  kegs  or  boxes,  securely  strapped  with  hoop 
iron,  and  carefully  sealed  with  private  seals;  the  latter  to  dis- 

1  Address  by  H.  K.  Brooks,  Lectures  on  Commerce,  Edited  by  Henry 
Rand  Hatfield,  University  of  Chicago  Publications  of  the  College  of  Com- 
merce and  Administration,  Vol.  I.,  pp.  283-4.  The  University  of  Chicago 
Press.  Chicago.  1904. 


THE  SILVER  EXCHANGES  351 

cover  if  tampered  with  en  route.  Space  is  chartered  from  the 
steamship  company,  as  in  the  case  of  merchandise,  although 
nearly  all  large  fast  steamers  have  rooms  especially  constructed 
for  such  valuable  cargo.  ...  As  an  extra  safeguard  in  case 
of  large  shipments,  the  steamship  company  details  special 
armed  men  to  guard  the  room  day  and  night,  and  sometimes 
the  shipper  employs  special  detectives  in  citizens'  clothes  to 
watch  the  passengers  on  the  trip,  since  it  is  generally  known 
several  days  in  advance  when  large  shipments  of  gold  are  to 
be  made. 

THE  SILVER  EXCHANGES 

1.  .  .  It  is  acknowledged  that  commerce  between  gold  stand- 
ard countries  is  satisfactory  to  all  classes  of  traders,  for  both 
importers  and  exporters  know  exactly  the  return  they  may 
expect,  but  in  trade  between  a  silver-using  country  and  one 
on  a  gold  basis,  a  large  measure  of  uncertainty  invariably  ex- 
ists. Whenever  there  is  a  fall  in  the  gold  value  of  silver, 
either  the  exporter  in  the  gold  standard  country  or  the  im- 
porter in  the  silver  country  must  suffer. 

Let  us  take  the  case  of  the  exporter.  We  will  suppose  that 
A.  Blank  &  Company,  of  Manchester,  calico  printers,  send 
goods  to  Shanghai,  which  they  hope  to  sell  there  for  a  total 
sum  of,  say,  £1,000.  The  price  of  silver  when  the  shipment 
was  despatched  was,  we  will  say,  25^.  per  standard  ounce,  and 
on  this  basis  A.  Blank  &  Company  have  calculated  the  selling 
price  which  is  to  yield  them  £1,000.  By  the  time  the  calico 
arrives  in  Shanghai,  the  gold  price  of  silver  has  dropped,  we 
will  suppose,  to  2od.  per  standard  ounce,  and  this  obviously 
indicates  that  the  manufacturers  will  receive  one-fifth  less  for 
their  wares,  since  they  are  paid  in  the  currency  of  the  province 
(taels  in  this  instance),  and 'when  Blank  &  Company's  money 
comes  to  be  converted  back  into  British  gold  pieces,  they  are 
face  to  face  with  the  fact  that  the  outturn  is  £200  less  than 
they  had  calculated :  they  have  lost  one-fifth,  and  receive  £800 
only.  This  is,  of  course,  an  extreme  case,  as  in  the  ordinary 
course  silver  would  be  unlikely  to  drop  5^.  in  the  period  be- 

1  William  F.  Spalding,  Foreign  Exchange  and  Foreign  Bills  in  Theory 
and  in  Practice,  pp.  133-140.  Sir  Isaac  Pitman  &  Sons,  Ltd.,  Bath,  New 
York  and  Melbourne.  1915. 


352  FOREIGN  EXCHANGE 

tween  shipment  and  arrival  of  the  goods  in  Shanghai ;  but 
whatever  the  fall,  the  principle  is  the  same,  and  the  illustration 
serves  to  show  exactly  what  happens. 

It  is  not  only  the  British  exporters  who  stand  to  lose  in  the 
lottery  of  trade  with  countries  which  have  an  unstable  silver 
exchange;  the  capitalist  also,  and  every  class  of  investor,  is 
liable  to  be  adversely  affected  in  operations  with  silver  stand- 
ard countries.  The  rate  of  exchange  between  such  countries 
and  gold  standard  countries  is  plainly  the  exchange  between 
gold  and  silver;  therefore,  if  a  person  has  invested  in  under- 
takings in  the  silver  country,  when  he  receives  his  dividends 
in  the  currency  of  that  country,  he  will  obtain  less  for  his 
dividend  warrant  on  the  London  market  in  proportion  to  the 
fall  in  the  price  of  silver  —  assuming  that  it  does  fall.  Con- 
versely, he  may  reap  a  higher  return  on  his  investment  if  silver 
has  gone  up  before  the  encashment  of  his  dividend. 

Finally,  the  principal  is  affected  in  the  same  way,  whenever 
it  is  desired  to  convert  it  back  into  gold.  A  further  example 
will  show  how  this  works  out  in  practice. 

We  may  assume  that  an  investor,  encouraged  by  the  chance 
of  earning  6  per  cent,  on  his  money,  remits  to  China  £1,000. 
The  price  of  silver  on  the  ist  January,  1914,  was  26  7/160?. 
per  ounce  standard;  on  the  3ist  December,  1914,  22  n/i6d 
For  the  sake  of  argument,  we  will  imagine  our  investor  sent 
the  money  out  to  the  Eastern  country  on  the  ist  January,  1914, 
but  circumstances  made  it  advisable  for  him  to  recall  his  money 
at  the  end  of  December  in  the  same  year,  when  the  metal  had 
depreciated  to  22  n/i6d. ;  in  converting  his  principal  back  to 
British  currency  he  will  find  himself  faced  with  a  sharp  loss. 
Silver,  in  which  the  investment  stood,  has  dropped  3^4^.  of  its 
gold  equivalent,  roughly,  one-seventh;  consequently  on  con- 
version the  gold  value  of  his  original  £1,000  has  fallen  to 
about  £857.  .  .  . 

.  .  .  The  exchanges  of  these  silver  standard  countries  .  .  . 
[are]  quoted  in  shillings  and  pence  to  the  dollar,  tael,  or  rupee, 
as  the  case  may  be,  that  is,  the  gold  value  of  the  respective 
silver  coins.  Hong-Kong,  for  instance,  is  quoted  is.  io^d. 
to  the  dollar,  and  Shanghai,  2s.  S^rf.  to  the  tael.  The  rates 
from  these  centres  .  .  .  indicate  the  price  for  telegraphic 


THE  SILVER  EXCHANGES  353 

transfers  on  London:  the  unit  of  exchange  in  the  centres 
named  being  by  general  consent  the  rate  for  telegraphic  trans- 
fers on  London. 

Let  us  take  the  Shanghai  rate  as  an  example:  2s.  $^d.  per 
tael,  means  that  for  every  silver  tael  the  remitter  hands  over 
to  the  exchange  bank  in  Shanghai,  2s.  5^rf.,  or,  to  give  it  its 
real  significance,  a  little  less  than  one-eighth  of  a  sovereign  in 
gold,  will  be  paid  to  the  person  in  whose  favour  the  remittance 
is  made,  as  soon  as  a  telegram  can  reach  the  bank's  London 
branch.  .  .  . 

.  .  .  Besides  the  T.  T.  rate,  as  it  is  called  for  the  sake  of 
brevity,  we  have  the  four  months'  sight  and  six  months'  sight 
rates,  which  are  the  quotations  for  first-class  bank  bills.  Both 
quotations  are  higher  than  for  the  telegraphic  transfers,  that 
is  to  say,  for  every  silver  tael  paid  in  Shanghai  the  bank  will 
allow  more  shillings  and  pence  where  it  is  a  question  of  paying 
the  gold  value  in  London  four  or  six  months  hence,  than  it 
would  if  the  payment  is  to  be  made  on  demand  or  by  wire. 
The  reason  is,  that  if  a  bill  drawn  on  London,  payable  four 
months  after  sight,  is  sent,  the  remitter  is  bound  to  place  the 
receiver  in  such  a  position  that  if  the  latter  chooses  to  turn 
the  bill  into  cash  after  it  has  been  "  sighted  "  and  accepted,  he 
will  not  be  worse  off  than  if  the  money  had  been  sent  by 
cable.  ... 

As  may  be  gathered,  therefore,  the  discount  rates  ruling  on 
the  London  market  are  of  great  importance  to  the  Eastern 
bankers  and  exchange  dealers:  so  important  are  they  in  fact, 
that  it  is  necessary  for  each  side  to  keep  in  direct  telegraphic 
communication  regarding  the  existing  discount  quotations  and 
the  probable  trend  of  the  markets.  .  .  . 

.  .  .  The  rate  at  which  they  are  able  to  cover  their  drawing 
operations  .  .  .  governs  the  price  at  which  they  will  sell  bills. 
If  a  banker  has  funds  deposited  with  his  correspondent  upon 
which  he  can  draw,  well  and  good:  if  he  has  no  balance  with 
the  agent,  he  must  either  provide  the  wherewithal  to  meet  the 
bills  which  he  has  drawn,  or,  alternatively,  he  can  instruct  the 
agent  to  draw  on  him  in  reimbursement.  Finally,  there  comes 
a  time,  .  .  .  when,  as  all  other  means  of  placing  his  corre- 
spondent in  funds  have  been  exhausted,  the  banker  will  be 


354  FOREIGN  EXCHANGE 

obliged  to  ship  .  .  .  silver  to  be  sold  for  what  it  will 
fetch.  .  .  . 

It  is  fairly  clear  that  the  real  trouble  in  Eastern  exchange 
lies  in  the  fact  that  we  have  three  main  factors  to  deal  with 
instead  of  two.  In  the  gold  exchanges  we  have  simply  the 
demand  for  and  supply  of  bills  and  telegraphic  transfers ;  in 
the  silver  exchanges  the  matter  is  complicated  by  the  way  in 
which  we  also  have  to  depend  upon  the  fluctuations  in  the 
price  of  silver  on  the  London  market.  .  .  . 

Shanghai  draws  on  London  for  the  cost  of  her  exports  and 
remits  to  London  for  the  value  of  her  imports,  and  the  prin- 
cipal reason  for  this  procedure  is  that  the  manufacturer  in 
Great  Britain  does  not  wish  to  be  bothered  with  the  variations 
in  exchange,  although  as  the  reader  has  seen,  he  may  be  pretty 
severely  affected  if  silver  has  depreciated  before,  his  goods  are 
sold.  Leaving  that  out  of  the  question,  however,  we  may 
take  it  that  as  all  his  expenses  are  payable  in  gold,  he  naturally 
prefers  to  deal  in  terms  of  that  metal.  Consequently,  goods 
shipped  to  China  are  nearly  always  paid  for  by  remittances, 
or  drawn  for  in  sterling,  which  comes  to  the  same  thing.  The 
Chinese  producer  is  on  rather  a  different  footing.  His  ex- 
penses are  in  silver,  and  in  silver  he  wishes  to  be  paid.  His 
produce,  however,  he  has  sold  to  Great  Britain  for  a  gold  price, 
and  either  he  cannot  afford  to,  or  does  not  want  to  wait  until 
a  remittance  can  be  sent  by  mail  from  London.  The  one  way 
open  to  him  is  to  draw  in  sterling  and  settle  the  rate  of  ex- 
change on  the  spot,  which  he  does  and  so  makes  an  end  of  the 
matter.  , 


CHAPTER  XIX 
CLEARING  HOUSES 

The  following  discussion  of  clearing  houses  is  confined  mainly  to  the 
United  States  and  England.  References  to  the  clearing  houses  of  France 
and  Germany,  where  the  introduction  of  the  use  of  checks  and  the  conse- 
quent development  of  clearing  facilities  have  been  tardy,  are  contained  in 
the  chapters  devoted  to  the  banking  systems  of  those  countries. 

I.  IN  THE  UNITED  STATES 

A   CLEARING   HOUSE  DEFINED 

1  WHAT  is  a  clearing  house  ?  The  Supreme  Court  of  the 
State  of  Pennsylvania  has  defined  it  thus: 

It  is  an  ingenious  device  to  simplify  and  facilitate  the  work  of  the 
banks  in  reaching  an  adjustment  and  payment  of  the  daily  balances 
due  to  and  from  each  other  at  one  time  and  in  one  place  on  each 
day.  In  practical  operation  it  is  a  place  where  all  the  representa- 
tives of  the  banks  in  a  given  city  meet,  and,  under  the  supervision 
of  a  competent  committee  or  officer  selected  by  the  associated  banks, 
settle  their  accounts  with  each  other  and  make  or  receive  payment 
of  balances  and  so  "  clear  "  the  transactions  of  the  day  for  which 
the  settlement  is  made. 

But  we  must  go  farther  than  this,  for  though  originally 
designed  as  a  labor-saving  device,  the  clearing  house  has 
expanded  far  beyond  those  limits,  until  it  has  become  a  medium 
for  united  action  among  the  banks  in  ways  that  did  not  exist 
even  in  the  imagination  of  those  who  were  instrumental  in  its 
inception.  A  clearing  house,  therefore,  may  be  defined  as  a 
device  to  simplify  and  facilitate  the  daily  exchanges  of  items 
and  settlements  of  balances  among  the  banks  and  a  medium 
for  united  action  upon  all  questions  affecting  their  mutual  wel- 
fare. 

1  James  G.  Cannon,  Clearing  Houses,  Publications  of  the  National 
Monetary  Commission,  Senate  Document,  No.  491,  6ist  Congress,  2nd  Ses- 
sion, p.  I. 

355 


356  CLEARING  HOUSES 

METHODS    OF   EXCHANGE    IN    NEW    YORK    PRIOR   TO    1853 

1  During  a  comparatively  short  period  immediately  follow- 
ing 1849  tne  number  of  banks  in  New  York  increased  from 
24  to  60.  In  the  daily  course  of  business  each  bank  received 
checks  and  other  items  on  each  of  the  other  banks,  which  had 
to  be  presented  for  collection.  All  such  items  on  hand  were 
assorted  and  listed  on  separate  slips  at  the  close  of  the  day, 
and  items  coming  in  through  the  mail  on  the  following  morn- 
ing were  added  at  that  time.  To  make  the  daily  exchanges 
each  bank  sent  out  a  porter  with  a  book  of  entry,  or  pass  book, 
together  with  the  items  to  be  exchanged. 

The  receiving  teller  of  the  first  bank  visited  entered  the  ex- 
changes brought  by  the  porter  on  the  credit  side  of  his  book 
and  the  return  exchanges  on  the  debit  side,  who  then  hurried 
away  to  deliver  and  receive  in  like  manner  at  the  other  banks. 
It  often  happened  that  five  or  six  porters  would  meet  at  the 
same  bank,  thereby  retarding  one  another's  progress  and  caus- 
ing much  delay.  Considerable  time  was  consumed  in  making 
the  circuit.  Hence,  the  entry  of  the  return  items  in  the  books 
of  the  several  banks  was  delayed  until  the  afternoon,  at  an 
hour  when  the  other  work  of  the  bank  was  becoming  urgent. 

A  daily  settlement  of  the  balances  was  not  attempted  by  the 
banks,  owing  to  the  time  it  would  have  required,  but  they  in- 
formally agreed  upon  a  weekly  adjustment,  the  same  to  take 
place  after  the  exchanges  on  Friday  morning.  At  that  time 
the  cashier  of  each  bank  drew  a  check  for  each  of  the  several 
balances  due  it,  and  sent  a  porter  out  to  collect  them.  At  the 
same  time  the  porter  carried  coin  with  which  to  pay  balances 
due  by  his  bank.  After  the  settlement  had  been  made,  there 
was  a  meeting  to  adjust  differences  and  bring  order  out  of 
chaos. 

An  old  bank  officer  (J.  S.  Gibbons),  in  describing  the  in- 
conveniences and  defects  of  this  system,  says  that  some  of  the 
more  speculative  banks  took  advantage  of  the  weekly  method 
of  settlements  by  carrying  a  line  of  discounts  to  an  amount 
greater  than  their  legitimate  resources  would  allow.  Thus,  a 
bank  would  manage  to  carry  a  small  debit  balance  of  $2,000 

id.,  pp.  148-150. 


ORIGIN  OF  NEW  YORK  CLEARING  HOUSE  357 

or  $3,000  with  thirty  or  more  institutions,  making  a  total  debit 
balance  of,  say,  $100,000  on  which  it  discounted  paper.  It 
was  the  practice  to  borrow  enough  on  Thursday  to  make  the 
settlements  on  Friday,  and  the  return  of  the  loan  on  Saturday 
threw  it  again  into  the  debtor  column.  Virtually,  therefore, 
the  weekly  settlements  were  nominal  only,  and  to  show  that 
there  was  no  attempt  at  economy  of  time  and  labor  in  making 
them,  it  is  only  necessary  to  say  that  the  cashier  drew  a  check 
for  every  balance  due  him,  whereas  a  draft  on  one  bank  in 
favor  of  another  might  have  settled  two  accounts  at  once. 

The  banks  were  at  liberty  to  draw  on  each  other  for  their 
credit  balances  without  waiting  for  the  settlements  on  Friday, 
and  hence,  when  specie  was  needed,  this  was  not  infrequently 
done.  But  so  far  did  many  of  the  banks  extend  their  loans 
and  discounts  that  a  single  small  draft  by  one  bank  on  another 
would  induce  a  general  drawing  and  involve  them  all  in  con- 
fusion and  virtual  war  on  each  other.  Three  o'clock  would 
arrive,  with  the  line  of  drafts  incomplete,  thus  enabling  debtor 
banks  ofttimes  to  add  $50,000  to  their  specie,  whereas  creditor 
banks  would  find  themselves  at  the  close  of  the  day  depleted 
in  perhaps  twice  that  sum.- 

THE   ORIGIN   OF   THE   NEW   YORK   CLEARING   HOUSE 

1  The  desirability  of  a  substitute  for  such  a  system  had  long 
been  realized,  but  as  yet  no  plausible  scheme  had  been  proposed. 
As  early  as  1831  a  plan  had  been  suggested  by  Albert  Gallatin, 
which,  to  a  very  remarkable  degree,  coincided  with  the  one 
ultimately  adopted. 

But  the  times  were  not  ripe  for  the  scheme  thus  proposed. 
Mr.  Gallatin  was  thinking  in  advance  of  the  age.  In  time, 
however,  the  question  began  to  be  more  generally  discussed. 
For  nearly  a  year  it  was  under  consideration,  and  finally  it  was 
deemed  advisable  to  call  a  meeting  to  take  decisive  action 
upon  it. 

On  August  23,  1853,  1 6  presidents,  i  vice-president,  and  21 
cashiers,  representing  38  banks,  assembled  in  the  directors' 
room  of  the  Merchants'  Bank,  and  at  this  meeting  a  resolu- 
tion was  passed  providing  that  "  a  committee  be  appointed  to 

1 /&«/.,  pp.  150-154. 


358  CLEARING  HOUSES 

procure  or  hire  a  suitable  room  in  or  near  Wall  Street,  for  the 
purpose  of  holding  meetings  of  the  officers  of  the  city  banks; 
that  the  said  committee  be  requested  to  submit  a  plan,  at  an 
adjourned  meeting  of  this  body,  to  simplify  the  system  of 
making  exchanges  and  settling  the  daily  balances;  and  that 
when  a  room  is  procured  or  hired  for  the  above  purpose,  the 
presidents  or  cashiers  be  requested  to  meet  weekly  until  a  plan 
is  agreed  upon."  In  compliance  with  this  request,  the  com- 
mittee presented  a  plan  for  the  daily  settlement  of  balances, 
at  a  meeting  held  on  August  31,  1853,  which  plan  was  amended 
so  as  to  provide  "  that  a  room  be  procured  for  that  purpose, 
sufficiently  large  to  afford  suitable  accommodations." 

On  September  13,  1853,  the  scheme  was  adopted  and  the 
committee  was  "  clothed  with  full  power  to  hire  a  room,  ap- 
point a  manager  and  clerks,  and  make  all  the,  necessary  ar- 
rangements to  carry  the  plan  for  a  clearing  house  into  effect." 
The  date  for  beginning  operations  was  fixed  for  October  u. 
Accordingly,  on  the  appointed  day,  the  representatives  of  the 
banks,  members  of  the  association,  met  in  a  room  which  had 
been  procured  in  the  basement  at  No.  14  Wall  Street,  and  made 
the  first  exchanges.  The  total  clearings  on  that  day  were 
$22,648,109.87,  and  the  balances  were  $1,290,572.38.  These 
clearings  have  since  been  eclipsed  by  over  $30,000,000  in  the 
totals  of  a  single  bank. 

The  clearing  system  in  America  was  thus  fairly  launched, 
and  from  that  time  forth  its  success  exceeded  the  expectations 
of  even  its  most  ardent  projectors.  The  association  consisted 
at  that  time  of  52  banks,  banded  together  for  their  common 
good,  which,  as  they  then  conceived,  consisted  solely  in  the 
exchange  of  items  and  settlement  of  balances  at  a  uniform  time 
and  place.  For  nearly  a  year  the  operations  were  conducted 
without  a  constitution.  The  adoption  of  such  an  instrument 
was  opposed,  on  the  ground  that  it  was  not  needed  and  might 
lead  to  a  dangerous  concentration  of  power  in  the  hands  of 
a  few  managers,  who  might  use  it  for  personal  aggrandize- 
ment, or  for  the  exercise  of  an  arbitrary  supervision. 


CONSTITUENCY  AT  NEW  YORK  359 

MEMBERSHIP  AND  ADMITTANCE  FEES  AT  NEW   YORK 

1  The  association  at  present  (1909)  consists  of  50  mem- 
bers 2  (32  National  Banks  and  18  State  Banks)  and  the  United 
States  subtreasury  located  at  New  York.  The  latter  makes 
its  exchanges  only  at  the  clearing  house,  its  balances  being  set- 
tled at  its  own  counter.  It  has  no  voice  in  the  government  of 
the  association,  and  pays  a  nominal  sum  for  actual  expenses. 
The  privilege  which  the  subtreasury  enjoys  of  making  its  ex- 
changes through  the  clearing  house  is  a  matter  of  great  ac- 
commodation both  to  the  subtreasury  and  to  the  banks.  The 
New  York  post-office  clears  through  one  of  the  members,  but 
renders  no  compensation  to  the  association  for  the  privilege. 

The  membership  of  the  association  since  its  organization 
has  been  constantly  changing,  owing  to  the  admission  and 
expulsion  of  members  and  voluntary  withdrawals,  as  provided 
by  the  constitution. 

The  association  began  with  51  members,  but  by  1858  the 
list  had  declined  to  46,  the  lowest  number  in  the  history  of 
the  clearing  house.  A  membership  of  67  was  attained  in 
1895. 

On  February  28,  1854,  the  Bank  of  the  Union  was  expelled 
and  the  clearing-house  association  was  authorized  to  return  to 
it  whatever  amount  was  necessary  to  offset  its  advances  to- 
ward the  expenses  of  the  clearing  house.  In  the  following 
December  the  Empire  City  Bank  was  expelled  and  a  similar 
resolution  was  passed  but  in  no  case  thereafter  were  any  such 
refunds  made.  .  .  . 

The  constitution  is  very  explicit  in  its  terms  governing  the 
admission  and  conduct  of  members.  Applicants  are  first  con- 
sidered by  the  clearing-house  committee  and  referred  hence 
to  the  committee  on  admissions.  The  latter  committee,  if,  in 
its  opinion,  after  a  careful  examination,  the  applicants  are 
qualified  for  membership,  refers  them  to  the  association  for 
final  action,  a  three-fourths  vote  of  those  present  being  neces- 
sary for  admission.  Banks  may  be  elected  to  membership  at 
any  meeting  of  the  association,  but  before  being  considered 
by  the  clearing-house  committee  each  applicant  must  be  shown 

1  Ibid.,  pp.  163-165.  2  [62  members  in  1914.] 


360  CLEARING  HOUSES 

to  have  an  unimpaired  capital  or  an  unimpaired  capital  and 
surplus  of  at  least  $500,000.  Each  new  member  is  required 
to  signify  its  assent  to  the  constitution,  in  the  same  manner  as 
the  original  members,  and  pay  an  admission  fee,  according 
to  capital,  as  follows :  A  bank  the  capital  of  which  does  not 
exceed  $5,000,000  must  pay  $5,000;  a  bank  the  capital  of 
which  exceeds  $5,000,000  must  pay  $7,500.  Any  member 
increasing  its  capital  is  required  to  pay  in  accordance  with 
those  rates. 


1  METHODS   OF   SETTLING   BALANCES 

There  are  no  less  than  five  different  methods  of  settling 
balances,  in  whole  or  in  part,  without  the  use  of  money  at 
the  clearing  house.  They  are  (i)  by  manager's  check  on 
debtor  banks  given  to  creditor  banks;  (2)  by  borrowing  and 
loaning  balances  without  interest ;  ( 3 )  by  borrowing  and  loan- 
ing balances  with  interest;  (4)  by  the  use  of  one  or  more  of 
four  forms  of  certificates,  viz.,  gold  and  currency  depository 
certificates,  United  States  assistant  treasurer  certificates,  and 
clearing-house  loan  certificates;  and  (5)  by  draft  on  another 
city. 

When  money  is  not  used  in  the  adjustment  of  balances  at 
the  clearing  house,  one  of  the  most  common  methods  of  settle- 
ment is  by  manager's  check  on  debtor  banks  in  favor  of 
creditor  banks.  In  such  cases  the  creditor  banks  send  clerks 
to  the  clearing  house  to  receive  the  manager's  checks,  which 
may  be  cashed  by  the  debtor  banks,  exchanged  for  cashier's 
checks  or  exchange  on  another  city,  or  sent  through  the  clear- 
ings on  another  day. 

There  is  one  important  advantage  of  the  manager's  check 
over  settlements  in  cash  at  the  clearing  house:  By  its  use 
only  one  transfer  of  cash  is  necessary  in  making  settlements, 
and  thus  the  risk  is  greatly  diminished. 

The  second  mode  of  settlement,  other  than  on  a  cash  basis, 
is  by  borrowing  and  loaning  balances  without  interest.  At 
Chicago  and  Pittsburg  this  method  is  practised  as  a  matter 
of  convenience  to  the  several  members.  After  the  exchanges 

1  Ibid.,  pp.  41,  43,  44-46. 


METHODS  OF  SETTLING  BALANCES  361 

have  been  made  and  the  balances  determined,  a  certain  length 
of  time  is  devoted  to  this  transfer. 

The  third  method  is  that  of  borrowing  and  loaning  balances 
upon  interest,  "as  practised  in  Boston. 

The  fourth  method  is  that  of  employing  some  form  of 
certificate.  Many  of  the  large  clearing  houses  provide  for 
a  depository  to  receive  in  special  trust  such  United  States 
gold  coin  as  any  of  the  banks  belonging  to  the  association 
may  voluntarily  deposit  with  it  for  safe-keeping,  upon  which 
certificates  may  be  issued,  to  be  used  in  the  settlement  of 
clearing-house  balances.  Such  certificates  are  usually  issued 
in  denominations  of  $5,000  and  $10,000,  and  are  negotiable 
only  among  the  associated  banks.  Many  of  the  clearing 
houses  impose  a  fine  for  their  transfer  to  any  other  party 
than  a  member  of  the  association. 

Coin  certificates  were  devised  by  F.  W.  Edmunds  of  New 
York,  and  came  into  use  about  1857.  The  Bank  of  America 
first  acted  as  a  depository,  but  after  the  beginning  of  the  green- 
back epoch  the  associated  banks  chose  the  United  States  sub- 
treasury  as  such  depository  for  both  gold  and  currency.  When 
the  new  clearing  house  in  Cedar  Street  was  occupied,  the  gold 
deposits  were  transferred  to  the  magnificent  vaults  with  which 
it  is  provided,  and  these  at  the  present  time  hold  a  very  heavy 
deposit  of  gold,  as  well  as  a  very  large  amount  of  currency, 
against  which  have  been  issued  clearing-house  certificates  as 
before  mentioned.  The  associations  in  practically  all  of  the 
large  cities  of  the  United  States  now  use  these  gold  depository 
certificates  in  the  settlement  of  clearing-house  balances. 

Clearing-house  loan  certificates  are  issued  only  in  emergen- 
cies. The  period  during  which  balances  are  settled  by  such 
instruments  lasts  usually  only  three  or  four  months,  or  until 
the  financial  disturbance  which  called  them  forth  has  subsided. 

The  fifth  method  is  by  draft  on  some  other  city.  In  some 
places  the  option  is  given  of  settling  in  cash  or  by  draft,  as  at 
Austin,  Tex. ;  Charleston,  S.  C. ;  Frederick,  Md. ;  Jacksonville, 
Fla. ;  Kansas  City,  Mo. ;  New  Orleans,  La. ;  Rochester,  N.  Y. ; 
and  Saginaw,  Mich.  In  others  settlements  are  made  exclu- 
sively by  drafts  on  another  city.  Among  these  are  Syracuse, 
N.  Y. ;  Worcester,  Mass. ;  Fall  River,  Mass. ;  Fremont,  Ohio ; 


362  CLEARING  HOUSES 

Hartford,  Conn. ;  Holyoke  and  Lowell,  Mass. ;  and  Bingham- 
ton,  N.  Y.  Sometimes  foreign  drafts  are  used  in  payments  of 
equal  thousands  only,  as  at  Wilmington,  Del.,  and  Chester,  Pa. 

Generally  speaking,  about  40  per  cent,  of  the  clearing  houses 
of  the  United  States  use  drafts  on  other  cities  in  paying  their 
balances.  About  30  per  cent,  settle  by  manager's  check,  and 
about  25  per  cent,  settle  by  cash  alone,  the  remaining  5  per 
cent,  settling  by  a  combination  of  two  or  more  of  the  foregoing 
methods. 

Clearing  houses  located  in  New  England  settle,  as  a  rule, 
with  drafts  on  Boston  or  New  York,  or  both.  Clearing  houses 
in  the  vicinity  of  Philadelphia  usually  settle  with  drafts  on 
that  city  or  on  New  York,  and  those  located  in  that  part  of  the 
country  lying  east  of  the  Mississippi  River  settle  more  or  less 
by  draft  on  New  York  or  Chicago.  Settlement  is  also  some- 
times made  by  draft  on  some  of  the  larger  cities,  such  as 
Baltimore,  Washington,  Savannah,  Kansas  City,  Detroit, 
Omaha,  and  San  Francisco. 

1  RATIO  OF   BALANCES   TO    CLEARINGS 

The  ratio  of  balances  to  clearings  depends  partly  upon  the 
number  of  banks,  but  much  more  upon  the  amount  and  char- 
acter of  their  business  and  upon  their  relations  one  to  another. 
This  is  illustrated  by  figures  which  have  just  been  collected, 
covering  the  transactions  for  the  year  1908.  At  Pittsburg, 
with  20  members  and  128  non-members  clearing  through  mem- 
bers, the  balances  were  16.5  per  cent  of  the  clearings;  at 
Buffalo,  with  n  members  and  7  non-members,  12  per  cent.; 
at  Chicago,  with  20  members  and  40  non-members  clearing 
through  members,  7.5  per  cent. ;  at  Philadelphia,  with  31  mem- 
bers and  i  non-member,  11.5  per  cent.;  at  St.  Louis,  with  17 
members  and  35  non-members,  9.3  per  cent. ;  while  in  New 
York,  during  the  fifty- four  years  of  its  existence,  the  per- 
centage of  balances  to  clearings  has  been  only  4.64  per  cent., 
notwithstanding  the  operation  of  the  United  States  assistant 
treasurer,  who  almost  always  has  a  heavy  debit  balance. 

The  more  nearly  the  banks  stand  on  an  equality  with  one 
another,  the  more  nearly  will  their  transactions  approach  a 

i  Ibid.,  p.  37. 


CLEARING-HOUSE  LOAN  CERTIFICATES  363 

complete  offset,  which,  of  course,  would  leave  no  balance  to 
settle. 


1  THE    NATURE   OF    CLEARING-HOUSE   LOAN    CERTIFICATES 

Clearing-house  certificates  are  of  two  kinds  —  those  issued 
upon  the  deposit  of  gold  coin  (and  in  New  York  City  and 
Boston  on  gold  and  silver  certificates  and  legal-tender  notes) 
and  those  issued  upon  the  deposit  of  collateral  securities.  The 
former  are  employed  in  ordinary  times  solely  as  a  method  of 
economizing  time  and  labor  and  reducing  risk  in  handling 
large  sums  of  money.  The  latter  are  employed  in  times  of 
financial  disturbance  or  panic,  and  although  both  are  intended 
for  use  solely  in  the  settlement  of  balances  at  the  clearing 
house,  the  circumstances  that  call  them  forth,  the  results  ef- 
fected by  their  use,  and  the  part  they  play  in  banking  economy 
have  little  or  nothing  in  common.  The  certificates  issued 
upon  the  deposit  of  gold,  etc.,  are  termed  "  Clearing-house 
certificates/-'  and  those  issued  upon  the  deposit  of  collateral 
security  are  very  properly  termed  "  Clearing-house  loan  cer- 
tificates," with  which  latter  only  are  we  here  concerned. 

Clearing-house  loan  certificates  may  be  defined  as  temporary 
loans  made  by  the  banks  associated  together  as  a  clearing- 
house association,  to  the  members  thereof,  for  the  purpose  of 
settling  clearing-house  balances.  Such  certificates  are  nego- 
tiable, as  a  rule,  only  among  the  members  of  the  association, 
and  are  not  in  any  sense  to  be  regarded  as  currency.  They 
are  not  even  seen  by  the  business  community,  and  do  not  pass 
from  bank  to  bank  except  in  payment  of  clearing-house  bal- 
ances. 

To  obtain  an  intelligent  understanding  of  the  real  char- 
acter and  purpose  of  such  certificates  it  will  be  well  to  treat 
somewhat  of  the  circumstances  under  which  they  are  issued. 
In  the  course  of  the  present  century  the  United  States  has 
undergone  periodical  derangements  of  business  affairs,  when 
confidence  was  displaced  by  mistrust,  when  the  payment  of 
debts  became  difficult,  when  property  values  declined,  and 
business  houses  failed;  when  industry  and  trade  were  para- 

i  Ibid.,  pp.  75-79- 


364  CLEARING  HOUSES 

lyzed,  and  general  stagnation  ensued  in  all  lines  of  enterprise. 
In  such  times  depositors  in  banks,  stricken  with  fear  and  some- 
times pressed  by  need,  draw  out  their  deposits,  in  many  cases 
to  such  an  extent  as  to  render  it  difficult  or  even  impossible 
for  the  banks  to  contract  their  loans  sufficiently  to  meet  the 
demands  thus  made  upon  them.  Under  our  currency  sys- 
tem no  adequate  method  is  [was]  provided  for  expanding  the 
money  volume  as  occasion  demands,  whereby  the  banks  can 
continue  their  usual  loans  and  discounts,  and  thus  prevent 
a  panic  with  all  its  evil  consequences.  Hence  it  is  left  in  a 
large  measure  to  the  financiers  of  each  community  to  work 
out  their  own  remedy,  supplemented  by  such  mutual  assist- 
ance as  a  courteous  regard  for  each  other  may  dictate  or  as 
business  relations  may  demand. 

Quick  to  see  the  defects  in  our  currency  system,  and  the 
desirability  of  in  some  way  supplying  it,  the  bankers  of  New 
York,  nearly  fifty  years  ago,  devised  the  scheme  of  issuing 
clearing-house  loan  certificates  as  a  method  of  relief  from 
temporary  stringencies.  Subsequently,  nearly  all  the  clearing 
houses  in  the  great  centres  adopted  the  same  device,  and  by 
their  heroic  resort  to  the  measure  they  have  at  different  times 
relieved  the  business  community  of  untold  disaster,  for  which 
invaluable  service  they  have  justly  received  the  grateful  recog- 
nition of  the  entire  country. 

The  great  value  of  clearing-house  loan  certificates  lies  in 
the  fact  that  they  take  the  place  of  money  in  settlements  at  the 
clearing  house,  and  hence  save  the  use  of  so  much  actual  cash, 
leaving  the  amount  to  be  used  by  the  banks  in  making  loans 
and  discounts,  and  in  meeting  other  obligations.  The  volume 
of  currency,  to  all  intents  and  purposes,  is  expanded  by  this 
means  to  the  full  amount  of  the  certificates  issued. 

The  loan  certificates  are  taken  out  by  the  clearing-house 
members  through  loan  committees,  specially  appointed,  and 
are  used,  as  a  rule,  only  in  the  payment  of  balances  among 
the  associated  banks.  Thus,  when  the  stringency  in  the  money 
market  seems  sufficient  to  demand  it,  the  clearing-house  asso- 
ciation meets  and  appoints  a  committee  called  the  "  loan  com- 
mittee," consisting  usually  of  five  bank  officers,  to  act  in  con- 


CLEARING-HOUSE  LOAN  CERTIFICATES  365 

currence  with  the  president  of  the  clearing-house  association, 
who  serves  ex  officio  as  a  member.  It  is  the  duty  of  such 
committee  to  meet  each  morning  at  the  clearing  house  and 
examine  the  collateral  offered  as  security  by  the  banks  and 
issue  loan  certificates  thereon,  in  such  denominations  and  pro- 
portions to  collaterals  deposited  as  may  be  agreed  upon.  In 
the  past  the  denominations  have  varied  from  25  cents  to 
$100,000  in  the  different  associations  and  in  proportions  vary- 
ing from  $50  to  $100  of  certificates  to  $100  of  collateral 
deposited. 

These  loan  certificates  bear  interest  at  rates  varying  from 
5  to  10  per  cent,  per  annum,  payable  by  the  banks  to  which 
they  are  issued  to  the  banks  receiving  such  certificates  in  set- 
tlement of  daily  balances.  Hence  the  interest  charged  against 
certain  banks  must  exactly  equal  and  offset  that  credited  to 
certain  other  banks.  The  aim  is  to  fix  the  rates  sufficiently 
high  to  insure  the  retirement  of  the  certificates  as  soon  as 
the  emergency  which  called  them  forth  has  passed  by.  As  a 
rule  they  are  retired  by  the  banks,  which  take  them  out  as 
soon  as  they  have  obtained  sufficient  cash  to  meet  their  daily 
obligations.  Notice  is  given  by  the  debtor  banks  to  the  com- 
mittee, calling  for  such  certificates  as  they  wish  to  retire,  and 
the  committee  gives  notice  to  the  banks  holding  the  same, 
stating  that  the  interest  will  cease  after  a  specified  date.  In 
due  course  the  holders  send  the  certificates  to  the  clearing 
house  for  redemption.  Upon  the  retirement  of  the  certifi- 
cates the  collateral  deposited  as  security  is  surrendered  by  the 
committee  in  the  same  proportion  to  certificates  turned  in  as 
was  required  for  deposit  at  the  time  of  issue. 

It  is  by  no  means  the  general  practice  for  all  the  members 
to  take  out  loan  certificates  when  issues  are  arranged  by  the 
association.  Some  banks  are  in  such  condition  as  to  be  able 
to  weather  the  storm  without  them,  while  others  are  weak 
and  in  great  need  of  relief.  Some  banks  regard  their  use 
of  clearing-house  loan  certificates  as  a  reflection  upon  their 
standing,  and  hence  refuse  to  apply  for  them  unless  driven  to 
it  by  sheer  necessity.  Others  regard  it  as  in  no  way  prejudi- 
cial to  their  interests,  but  rather  as  a  patriotic  movement  in 


366  CLEARING  HOUSES 

which  all  the  banks  should  engage,  both  for  the  purpose  of 
assisting  their  fellow-members  and  for  the  welfare  of  the 
community  as  a  whole. 

CLEARING-HOUSE   LOAN    CERTIFICATES   AND  THE   EQUAL- 
IZATION   OF   RESERVES  1 

Comparison  of  the  course  of  events  during  the  crisis  of  1873 
with  that  in  subsequent  crises  shows  a  progressively  increas- 
ing unwillingness  or  inability  among  the  New  York  banks  to 
make  use  of  their  cash  reserves.  In  1873  the  New  York  banks 
at  the  outset  of  the  crisis  held  an  available  reserve  of  $34,300,- 
ooo.  In  the  course  of  four  weeks  this  was  reduced  to  $5,800,- 
ooo,  and  the  ratio  to  deposit  liabilities  was  then  less  than  4.5 
per  cent.2  Suspension  was  not  escaped  in  1873. but  it  was  of 
shorter  duration  than  in  later  crises.  The  banks  at  that  time 
were  unable  to  increase  their  cash  resources  by  any  of  the 
means  which  have  been  available  in  later  crises.  The  Gov- 
ernment had  no  surplus  of  greenbacks,  aside  from  about  $12,- 
000,000  which  was  almost  entirely  secured  and  retained  by 
the  savings  banks.  Banknotes  could  not  be  issued  because  the 
total  circulation  was  at  that  time  limited  by  law.  Finally, 
additional  supplies  of  gold,  secured  through  imports,  were 
useless  for  ordinary  banking  purposes  because  the  business 
of  the  country  was  then  carried  on  by  means  of  an  incon- 
vertible and  depreciated  paper  currency.  Notwithstanding  all 
these  special  difficulties,  the  New  York  banks,  by  continuing 
to  use  their  reserves  freely  even  after  payments  had  been  re- 
stricted, were  able  to  restore  confidence  in  a  comparatively 
short  time,  and  money  began  to  flow  back  to  them  within  three 
weeks  after  the  outbreak  of  the  crisis. 

In  1893  the  New  York  banks  were  in  what  was  for  them 
an  unusually  strong  condition  at  the  beginning  of  the  dis- 
turbance, having  early  in  June  a  cash  reserve  exceeding  30 
per  cent,  of  their  net  deposits.  A  succession  of  banking  fail- 

aO.  M.  W.  Sprague,  Banking  Reform  in  the  United  States,  pp.  104-113. 
Harvard  University.  1911. 

2  The  figures  in  the  text  refer  to  the  legal  tender  holdings  of  the  banks. 
The  hanks  also  held  a  considerable  amount  of  specie  but  it  was  not  a 
free  asset,  as  most  of  it  had  been  received  on  special  accounts  payable  in 
gold.  Including  the  specie  holdings  the  reserve  ratio  was  12.8  per  cent. 


EQUALIZATION  OF  RESERVES  367 

tires  in  the  West  and  South  led  to  heavy  withdrawals  from 
New  York  during  the  latter  part  of  June  and  the  beginning  of 
July.  Then  followed  a  lull  and  money  began  to  be  returned 
to  New  York.  During  the  third  week  of  July  banking  fail- 
ures were  renewed  in  the  West  and  South  and  the  drain  was 
resumed.  The  positively  unfavorable  aspects  of  the  situa- 
tion were  altogether  similar  to  those  of  the  previous  month 
with  the  one  further  circumstance  of  a  reduced  cash  reserve 
in  New  York.  On  the  other  hand,  additional  means  with 
which  to  meet  the  situation  were  becoming  available.  At  the 
end  of  July  gold  imports  in  large  amount  had  been  arranged. 
Foreign  purchases  of  our  securities  were  heavy,  reflecting  in- 
creasing confidence  in  the  repeal  of  the  silver  purchase  law. 
Arrangements  had  also  been  made  which  would  certainly  lead 
to  a  considerable  increase  in  the  issues  of  banknotes  during 
August  and  September.  Notwithstanding  all  these  favor- 
able circumstances  the  New  York  banks  suspended,  during 
the  first  week  of  August,  when  they  still  held  a  cash  reserve 
of  $79,000,000,  more  than  20  per  cent,  of  their  deposit  lia- 
bilities. 

In  1907  the  New  York  banks  restricted  payments  when  they 
still  held  a  cash  reserve  of  more  than  $220,000,000  and  when 
the  reserve  ratio  was  also  above  20  per  cent.  Both  in  1893 
and  in  1907  suspension  was  not  a  measure  of  last  resort  taken 
after  the  banks  had  entirely  exhausted  their  reserves  and  when 
there  was  no  means  of  securing  additional  cash  resources. 
Moreover,  after  cash  payments  were  restricted  the  policy  of 
the  banks  was  unlike  that  adopted  in  1873,  in  that  the  banks 
did  not  make  further  use  of  their  reserves;  they  hoarded  them 
and  added  to  their  amount,  thus  unduly  prolonging  the  period 
of  suspension. 

Explanation  of  the  failure  of  the  banks  in  1893  and  1907 
to  use  their  cash  resources  as  completely  as  in  1873  is  simple; 
but  it  is  of  the  very  greatest  significance  because  it  will  bring 
to  light  the  most  serious  element  of  weakness  in  our  credit 
structure.  [Written  before  our  banking  reform  of  1913.] 

In  1893  and  in  1907  the  clearing-house  loan  certificate  was 
the  only  device  resorted  to  in  order  to  secure  the  adoption  of 
a  common  policy  by  the  banks.  In  1873,  as  on  earlier  occa- 


'368  CLEARING  HOUSES 

sions  when  its  use  was  authorized,  provision  was  also  made 
for  the  equalization  of  the  reserves  of  the  banks.  Thus  in 
1873  the  Clearing  House  Association  in  addition  to  the  cus- 
tomary arrangements  for  the  issue  of  loan  certificates  adopted 
the  following  resolution: 

That  in  order  to  accomplish  the  purposes  set  forth  in  this  agree- 
ment the  legal  tenders  belonging  to  the  associated  banks  shall  be 
considered  and  treated  as  a  common  fund,  held  for  mutual  aid  and 
protection,  and  the  committee  appointed  shall  have  power  to  equalize 
the  same  by  assessment  or  otherwise  at  their  discretion.  For  this 
purpose  a  statement  shall  be  made  to  the  committee  of  the  condi- 
tion of  such  bank  on  the  morning  of  every  day,  before  the  opening 
of  business,  which  shall  be  sent  with  the  exchanges  to  the  manager 
of  the  Clearing  House,  specifying  the  following  items: 

(i)  Loans  and  discounts.  (2)  Amount  of  loan  certificates. 
(3)  Amount  of  United  States  certificates  of  deposit  and  legal  tender 
notes.  (4)  Amount  of  deposits  deducting  therefrom  the  amount  of 
special  gold  deposits. 

Two  fairly  distinct  powers  were  given  the  clearing-house 
committee:  the  right  to  issue  clearing-house  certificates,  and 
control  over  the  currency  portion  of  the  reserves  of  the  banks. 
This  machinery  was.  devised  (according  to  tradition)  after 
the  crisis  of  1857  by  George  S.  Coe,  who  for  more  than  thirty 
years  was  president  of  the  American  Exchange  National  Bank. 
The  purpose  of  the  certificate  was  to  remove  certain  serious 
difficulties  which  had  become  generally  recognized  during  that 
crisis.  The  banks  had  pursued  a  policy  of  loan  contraction 
which  ultimately  led  to  general  suspension,  because  it  had 
proved  impossible  to  secure  any  agreement  among  them.1  The 
banks  which  were  prepared  to  assist  the  business  community 
with  loans  could  not  do  so  because  they  would  be  certain  to 
be  found  with  unfavorable  clearing-house  balances  in  favor 
of  the  banks  which  followed  a  more  selfish  course.  The  loan 
certificate  provided  a  means  of  payment  other  than  cash. 
What  was  more  important,  it  took  away  the  temptation  from 
any  single  bank  to  seek  to  strengthen  itself  at  the  expense  of 
its  fellows,  and  rendered  each  bank  more  willing  to  assist  the 
community  with  loans  to  the  extent  of  its  power. 

1  C.  F.  Dunbar,  Economic  Essays,  chap.  XVI. 


EQUALIZATION  OF  RESERVES  369 

But  in  addition  to  the  arrangement  for  the  use  of  loan  cer- 
tificates provision  was  also  made  for  what  was  called  the 
equalization  of  reserves.  The  individual  banks  were  not,  of 
course,  equally  strong  in  reserves  at  the  times  when  loan 
certficates  were  authorized.  From  that  moment  they  would 
be  unable  to  strengthen  themselves,  aside  from  the  receipt  of 
money  from  depositors,  except  in  so  far  as  the  other  banks 
should  choose  to  meet  unfavorable  balances  in  cash.  More- 
over, withdrawals  of  cash  by  depositors  would  not  fall  evenly 
upon  the  banks.  Some  would  find  their  reserves  falling  away 
rapidly  with  no  adequate  means  of  replenishing  them.  The 
enforced  suspension  of  individual  banks  would  pretty  cer- 
tainly involve  the  other  banks  in  its  train.  Finally,  it  would 
not  be  impossible  for  a  bank  to  induce  friendly  depositors  to 
present  checks  on  other  banks  directly  for  cash  payment,  in- 
stead of  depositing  them  for  collection  and  probable  payment 
in  loan  certificates,  through  the  clearing  house.  The  arrange- 
ment for  equalizing  reserves  therefore  diminished  the  likeli- 
hood of  the  banks  working  at  cross  purposes  —  a  danger  which 
the  use  of  clearing-house  certificates  alone  cannot  entirely  re- 
move. 

These  arrangements  had  enabled  the  banks  to  pass  through 
periods  of  severe  strain  in  1860  and  in  1861  without  suspen- 
sion. In  both  instances  the  use  of  the  loan  certificate  was 
followed  immediately  by  an  increase  in  the  loans  of  the  banks, 
and  in  no  short  time  by  an  increase  in  their  reserves.  The 
situation  in  1873  was  more  serious,  and  as  events  proved,  the 
reserve  strength  of  the  banks,  while  sufficient  to  carry  them 
through  the  worst  of  the  storm,  was  not  enough  to  enable 
them  to  avoid  the  resort  to  suspension. 

In  1884,  the  next  occasion  when  clearing-house  loan  certifi- 
cates were  issued,  the  opposition  to  the  provision  for  the 
equalization  of  reserves  was  so  widespread  that  it  does  not 
appear  that  it  was  even  formally  considered.  The  ground  for 
this  opposition  can  be  readily  understood.  In  1873  the  prac- 
tice of  paying  interest  upon  bankers'  deposits  was  generally 
regarded  with  disfavor.  Only  twelve  of  the  clearing-house 
banks  offered  this  inducement  to  attract  deposits;  but  by  this 
means  they  had  secured  the  bulk  of  the  balances  of  outside 


370  CLEARING  HOUSES 

banks.  It  was  in  meeting  the  requirements  of  these  banks 
that  the  reserves  of  all  the  banks  were  exhausted  at  that  time. 
The  non-interest  paying  banks  entered  into  the  arrangement 
for  the  equalization  of  reserves  in  expectation  of  securing  a 
clearing-house  rule  against  the  practice  of  paying  interest  on 
deposits.  But  their  efforts  had  resulted  in  failure.  Some  of 
them  had  employed  their  reserves  for  the  common  good  most 
reluctantly  in  1873,  and  the  feeling  against  a  similar  arrange- 
ment in  1884  was  naturally  far  stronger  and  more  general. 
Moreover,  the  working  of  the  pooling  agreement  in  1873  had 
occasioned  heart-burnings  which  had  not  entirely  disappeared 
with  the  lapse  of  time.  It  was  believed,  and  doubtless  with 
reason,  that  some  of  the  banks  had  evaded  the  obligations  of 
the  pooling  agreement.  It  was  said  that  some  of  the  banks 
had  encouraged  special  currency  deposits  so  as  not  to  be 
obliged  to  turn  money  into  the  common  fund.  Further,  as 
the  arrangement  had  not  included  banknotes,  banks  exchanged 
greenbacks  for  notes  in  order  either  to  increase  their  holdings 
of  cash  or  to  secure  money  for  payment  over  the  counter. 
Here  we  come  upon  an  objection  to  the  pooling  arrangement 
which  doubtless  had  much  weight  with  the  specially  strong 
banks,  although  it  is  more  apparent  than  real.  In  order  to 
supply  the  pressing  requirements  of  some  banks,  others  who 
believed  that  they  would  have  been  able  to  meet  all  demands 
of  their  depositors  were  obliged  to  restrict  payments.  That 
such  an  expectation  would  have  proved  illusory  later  experi- 
ence affords  ample  proof.  When  a  large  number  of  the  banks 
in  any  locality  suspend,  the  others  cannot  escape  adopting  the 
same  course.  But  in  1884  the  erroneousness  of  the  belief 
had  not  been  made  clear  by  recent  experience. 

The  New  York  banks  weathered  the  moderate  storms  of 
1884  and  1890  without  suspension,  by  means  of  the  clearing- 
house loan  certificate  alone,  and  in  the  course  of  time  all 
recollection  of  the  arrangement  for  the  equalization  of  re- 
serves seems  to  have  faded  from  the  memory  of  the  banking 
community.  There  was,  however,  in  those  years  another 
potent  influence  which  tended  to  lessen  the  likelihood  of  sus- 
pension following  the  issue  of  loan  certificates.  Many  banks 
were  unwilling  to  take  them  out,  fearing  that  such  action 


EQUALIZATION  OF  RESERVES  371 

would  be  regarded  as  a  confession  of  weakness.  The  preju- 
dice against  them  was  indeed  so  strong  that  needed  loan 
expansion  did  not  follow  the  authorization  of  their  issue.  In 
1890  the  directors  of  the  Bank  of  Commerce,  then,  as  now, 
one  of  the  most  important  banks  of  the  city,  passed  a  resolu- 
tion urging  other  banks  to  relieve  the  situation  by  increasing 
loans  and  by  taking  out  loan  certificates. 

In  1893  only  a  small  part  of  the  balances  between  the  banks 
was  settled  in  certificates  at  first ;  but  by  the  end  of  July  prac- 
tically all  balances  were  settled  in  that  way  and  suspension 
followed  at  once.  In  1907  all  the  banks  having  unfavorable 
balances,  with  but  one  important  exception,  took  out  certifi- 
cates on  the  first  day  that  their  issue  was  authorized,  and 
suspension  was  then  for  the  first  time  simultaneous  with  their 
issue. 

The  connection  between  suspension  and  the  use  of  clearing- 
house loan  certificates  as  the  sole  medium  of  payment  between 
the  banks  is  simple  and  direct.  The  bank  which  receives  a 
relatively  large  amount  of  drafts  and  checks  on  other  banks 
from  its  customers  cannot  pay  out  cash  indefinitely  if  it  is 
unable  to  secure  any  money  from  the  banks  on  which  they 
are  drawn.  So  long  as  only  a  few  banks  are  taking  out  cer- 
tificates and  the  bulk  of  payments  are  made  in  money,  no 
difficulty  is  experienced ;  but  as  soon  as  all  the  banks  make  use 
of  that  medium,  the  suspension  of  the  banks  which  have  large 
numbers  of  correspondents  soon  becomes  inevitable.  The 
contention  of  bankers  both  in  1893  and  in  1907  that  they  had 
not  suspended  since  they  had  only  refused  to  honor  drafts 
on  other  banks  was  untenable.  The  clearing-house  loan  cer- 
tificate was  a  device  which  the  banks  themselves  had  adopted 
and  they  had  failed  to  provide  any  means  for  preventing  par- 
tial suspension  as  the  result  of  its  use.  The  further  conten- 
tion of  some  bankers  that  they  had  suspended  because  they 
had  no  money  to  pay  out  was  doubtless  true  of  a  few  banks, 
but  for  that  very  reason  other  banks  must  have  been  all  the 
stronger,  probably  well  above  their  required  reserve. 

That  the  arrangement  for  equalizing  the  reserves,  adopted 
in  1873,  would  have  availed  to  prevent  suspension  on  subse- 
quent occasions,  is  highly  probable,  indeed  a  practical  cer- 


372  CLEARING  HOUSES 

tainty.  In  1893  events  proved  that  the  banks  had  maintained 
payments  up  to  the  very  last  of  the  succession  of  disasters 
with  the  results  of  which  they  had  been  contending.  During 
August  the  number  of  bank  failures  was  not  large  and  none 
of  them  was  of  great  importance.  We  cannot,  of  course, 
know  how  soon  money  would  have  begun  to  flow  back  to 
New  York,  but  certainly  the  suspension  of  payments  could 
hardly  have  hastened  the  movement.  From  the  beginning  of 
September  the  reported  movements  of  currency  showed  a 
gain  for  the  New  York  banks,  and  for  the  week  ending  Sep- 
tember 1 6  the  gain  was  no  less  than  $8,000,000.  One  month 
more  of  drain,  therefore,  was  the  most  that  the  banks  would 
have  been  obliged  to  endure,  and  for  the  needs  of  that  month 
the  banks  would  not,  as  in  1873,  have  been  confined  to  the 
single  resource  of  the  $79,000,000  of  the  cash  in  their  vaults.1 
Similarly,  the  enormous  increase  in  the  money  supply  of  the 
country  in  November  and  December,  1907,  would  have  offset 
much  of  the  loss  of  reserve  which  the  banks  would  have  in- 
curred, if  they  had  continued  to  meet  all  the  demands  of  their 
customers  for  cash.  And,  finally,  it  may  be  observed  that 
in  the  unlikely  event  that  alarm  had  not  been  allayed  and  sus- 
pension in  the  end  had  become  unavoidable,  it  would  not  have 
made  any  practical  difference  to  depositors  whether  the  re- 
serves of  the  banks  had  been  but  10  per  cent,  rather  than  20 
per  cent,  of  their  demand  liabilities. 

CLEARING-HOUSE   BANK   EXAMINATIONS  Z 

Most  bank  failures  are  due  to  the  gradual  acquirement  of 
undesirable  assets  over  a  period  of  years,  and  if  some  author- 
ity exists  with  power  to  make  recommendations  of  a  remedial 
character,  with  the  further  power  to  enforce  such  recom- 
mendations, if  necessary,  there  is  little  doubt  that  many  bank 
failures  would  be  averted. 

The  panic  of  1907  presented  many  striking  examples  of 
just  what  is  intended  to  be  here  emphasized,  viz.,  that  under 

1  The  increase  in  the  amount  of  money  in  circulation  for  August,  1893, 
was  estimated  at  $70,000,000. 

2  James  G.  Cannon,  Clearing  Houses,  Publications  of  the  National  Mone- 
tary Commission,  Senate  Document  No.  491,  6ist  Congress,  2<f  Session, 
PP.  I37-I4L 


CLEARING    HOUSE    BANK    EXAMINATIONS  373 

the  careful  supervision  of  a  competent  and  reliable  examiner 
many  of  the  assets  of  the  failed  banks,  upon  which  it  was 
impossible  for  them  to  realize  at  a  time  when  they  needed 
their  funds,  would  probably  have  been  liquidated  upon  his 
recommendation  and  advice  long  before  the  necessity  for  such 
liquidation  had  arisen. 

Mr.  J.  B.  Forgan  of  Chicago,  has  recently  said  on  this  sub- 
ject: 

A  competent  examiner  —  and  there  are  many  such  now  in  the 
government  employ  —  while  he  can  not  pass  judgment  on  all  the 
loans  in  a  bank,  can,  after  a  careful  examination,  or  a  series  of 
examinations,  form  a  wonderfully  correct  judgment  as  to  the  general 
character  of  its  assets  and  as  to  whether  its  management  is  good  or 
bad,  conservative  or  reckless,  honest  or  dishonest.  Examinations, 
as  they  are  now  conducted,  have  a  most  beneficial  influence  on  bank 
management,  especially  by  way  of  restraint.  The  correspondence 
carried  on  by  the  Comptroller,  based  on  the  examiners'  reports,  does 
an  inestimable  lot  of  good  in  the  way  of  forcing  bank  officers  to 
comply  with  the  law  and  in  compelling  them  to  face  and  provide  for 
known  losses  as  they  occur.  Supervision  by  examination  does  not, 
however,  carry  with  it  control  of  management  and  can  not,  there- 
fore, be  held  responsible  for  either  errors  of  judgment  or  lapses  of 
integrity.  Examination  is  always  an  event  after  the  act,  having  no 
control  over  a  bank's  initiative,  which  rests  exclusively  with  the 
executive  officers  and  directors,  and  depends  entirely  on  their  busi- 
ness ability,  judgment,  and  honesty  of  purpose. 

The  clearing-house  association  of  Chicago  was  the  pioneer 
in  the  establishment  of  an  independent  system  of  clearing- 
house bank  examinations  in  this  country,  its  system  having 
been  inaugurated  on  June  I,  1906,  with  results  that  have,  to 
the  present  time,  more  than  fulfilled  the  expectations  of  the 
bankers  of  that  community.1  .  .  . 

In  substantially  his  own  words  the  Chicago  examiner  oper- 
ates under  the  following  conditions :  The  examinations  ex- 
tend to  all  the  associated  banks  of  Chicago  and  to  all  non- 
member  institutions.  The  work  is  conducted  with  the  aid  of 
five  regular  assistants,  each  fitted  by  experience  to  thoroughly 
do  that  part  of  the  work  assigned  to  him.  The  examinations 
include,  besides  a  verification  of  the  assets  and  liabilities  of 

1  [A  number  of  the  more  important  cities  such  as  St.  Paul,  St.  Louis, 
and  Philadelphia,  following  the  example  of  Chicago  and  Minneapolis,  have 
instituted  clearing  house  bank  examinations  since  1907.] 


374  CLEARING  HOUSES 

each  bank,  so  far  as  is  possible,  an  investigation  into  the  work- 
ings of  every  department  and  are  made  as  thorough  as  is 
practicable.  After  each  examination  the  examiner  prepares 
a  detailed  report  in  duplicate,  describing  the  bank's  loans, 
bonds,  investments,  and  other  assets,  mentioning  specially  all 
loans,  either  direct  or  indirect,  to  officers,  directors,  or  em- 
ployees, or  to  corporations  in  which  they  may  be  interested. 
The  report  also  contains  a  description  of  conditions  found  in 
every  department.  One  of  these  reports  is  filed  in  the  vaults 
of  the  clearing  house,  in  the  custody  of  the  examiner,  and  the 
other  is  handed  to  the  examined  bank's  president  for  the  use 
of  its  directors.  The  individual  directors  are  then  notified 
that  the  examination  has  been  made  and  that  a  copy  of  the 
examiner's  report  has  been  handed  to  the  president  for  their 
use.  In  this  way  every  director  is  given  an  opportunity  to  see 
the  report,  and  the  examiner,  in  every  instance,  insists  upon 
receiving  acknowledgment  of  the  receipt  of  these  notices. 

The  detailed  report  retained  by  the  examiner  is  not  sub- 
mitted to  the  clearing-house  committee,  under  whose  direct 
supervision  he  operates,  unless  the  discovery  of  unusual  con- 
ditions makes  it  necessary.  A  special  report  in  brief  form  is 
prepared  in  every  case  and  read  to  the  clearing-house  com- 
mittee at  meetings  called  for  that  purpose.  The  report  is 
made  in  letter  form,  and  describes  .in  general  terms  the  char- 
acter of  the  examined  bank's  assets,  points  out  all  loans,  di- 
rect or  indirect,  to  officers,  directors,  or  employees,  or  to  cor- 
porations in  which  they  may  have  an  interest.  It  further 
describes  all  excessive  and  important  loans,  calls  attention  to 
any  unwarranted  conditions,  gross  irregularities,  or  danger- 
ous tendencies,  should  any  such  exist,  and  expresses,  in  a  gen- 
eral way,  the  examiner's  opinion  of  each  bank  as  he  finds  it. 

Less  than  a  year  after  the  Chicago  Clearing  House  Asso- 
ciation appointed  its  special  examiner  the  associated  banks  of 
Minneapolis  took  similar  action.  The  conditions  under  which 
the  Minneapolis  examiner  operates  are  substantially  the  same 
as  those  governing  the  examiner  at  Chicago,  the  principal 
difference  being  that  instead  of  the  examiner  sending  a  copy 
of  his  report  to  the  president  of  the  examined  bank  and 
notifying  each  of  the  directors  of  such  bank  that  he  has  made 


LONDON  CLEARING  HOUSE  375 

such  examination  and  that  the  report  is  in  the  hands  of  the 
president  of  the  institution,  as  is  the  rule  of  procedure  at 
Chicago,  and  which,  in  a  measure,  leaves  it  to  the  discretion 
of  the  directors  whether  they  examine  the  report  carefully 
and  in  detail,  the  original  report  is  delivered  by  the  examiner 
at  Minneapolis  in  person  to  the  board  of  directors  of  each 
bank  which  he  examines,  at  a  meeting  convened  for  that  pur- 
pose. The  report  is  read  and  the  criticisms,  if  any,  are  fully 
discussed,  and  the  recommendations  considered.  In  this  way 
no  director  can  complain  that  he  had  not  sufficient  opportunity 
to  become  fully  conversant  with  all  the  details  of  his  bank. 

II.     CLEARING  HOUSES  IN  ENGLAND 

THE  LONDON   BANKERS*    CLEARING   HOUSE  AS   THE   FORE- 
MOST  EXAMPLE 

1  The  exact  origin  of  the  London  Bankers'  Clearing  House 
will  probably  never  be  determined,  for,  like  other  institutions 
whose  purpose  has  been  to  save  time  and  trouble,  its  system 
appears  to  have  been  gradually  evolved.2 

With  the  growth  of  the  check  system,  each  banker  would 
daily  find  himself  in  possession  of  a  number  of  drafts  for  the 
credit  of  his  customers  that  needed  collection  at  the  offices 
of  other  bankers.  This  would  necessitate  each  bank  sending 
out  one  or  more  clerks  on  what  became  known  as  "  walks  " 
to  obtain  cash  or  notes  for  these  drafts  from  the  houses  on 
which  they  were  drawn. 

As  in  London  alone  there  were  some  fifty  or  more  private 
firms  carrying  on  a  banking  business  this  necessitated  a  con- 
siderable amount  of  work  and  was  attended  with  grave  risk 
of  robbery. 

It  is  probable,  therefore,  that  arrangements  were  made  by 
some  of  the  bankers,  as  it  is  still  done  in  some  country  towns, 
to  meet  at  one  bank  one  week  and  at  another  the  next  for  the 
purpose  of  exchanging  checks. 

1  Adapted  from  Robert  Martin  Holland,  The  London  Bankers  Clearing 
House,  Publications  of  the  National  Monetary  Commission,  Senate  Docu- 
ment No.  492,  6ist  Congress,  2nd  Session. 

2  The  date  of  the  establishment  of  the  Clearing  House  is  not  known. 
The  Clearing  has,  however,  been  in  existence  about  150  years. —  EDITOR. 


376  CLEARING  HOUSES 

But  in  consequence  of  the  number  of  the  London  bankers 
this  method  would  prove  awkward,  and  about  the  year  1770 
we  find  that  the  walk  clerks  from  the  city  and  West  End 
banks  had  made  a  practice  of  meeting  at  lunch  time  at  a 
public  house  called  the  Five  Bells  in  Dove  Court,  Lombard 
Street,  close  to  St.  Mary  Woolnoth  Church,  and  not  so  very 
far  from  the  site  of  the  Bankers'  Clearing  House  of  to-day. 
Here  in  the  public  room,  or  according  to  tradition  on  the  posts 
in  the  court  outside,  each  day  after  lunch  a  rough  system  of 
exchange  of  checks  was  carried  on  between  the  clerks  from 
each  bank,  the  balances  being  settled  in  notes  and  cash.  From 
this  rough  system  has  developed  the  efficient  organization  of 
to-day. 

In  May,  1854,  the  clearing  house  was  closed  for  altera- 
tions and  enlargement,  and  the  business  was  temporarily  car- 
ried on  at  the  Hall  of  Commerce.  Here,  on  June  6,  1854, 
applications  for  admission  to  the  clearing  house  were  received 
from  the  following  joint-stock  banks:  The  London  and 
Westminster,  the  London  Joint  Stock,  the  Union  Bank  of 
London,  the  Commercial  Bank  of  London,  and  the  London 
and  County  Bank;  and  it  was  resolved  "that  the  secretary  be 
authorized  to  comply  with  such  applications,  subject  to  the 
payment  of  an  annual  sum  to  be  fixed  by  the  committee  to 
reimburse  them  for  the  outlay  that  has  been  found  necessary 
to  afford  accommodation  for  their  admission."  There  were 
at  this  time  25  private  banks  in  the  clearing  house. 

Following  on  the  admission  of  the  five  premier  joint-stock 
banks  in  1854  there  were  frequent  applications  from  other 
joint-stock  banks  —  many  from  the  moment  of  their  founda- 
tion. But  the  wise  reply  of  the  committee  was  invariably  that 
they  did  not  "  deem  it  expedient  to  take  into  consideration 
such  applications  from  any  banking  establishment  that  has  not 
been  in  operation  at  least  for  a  period  of  twelve  months." 

Though  the  joint-stock  banks  had  been  admitted  to  the 
clearing  house  yet  they  were  only  allowed  to  rent  seats  there 
and  had  no  share  in  the  management,  so  for  the  support  of 
their  mutual  interests  they  had  a  committee  of  their  own  which 
settled  the  rate  to  be  given  by  the  joint-stock  banks  in  the 
London  district  for  deposit  money  at  seven  days'  notice. 


LONDON  CLEARING  HOUSE  377 

In  1858  the  country  bankers  submitted  a  plan  for  estab- 
lishing a  country  bankers'  clearing  house  in  London  and  pro- 
posed that  the  clearing  house  committee  should  appoint  two 
or  three  of  their  number  to  unite  with  them  as  a  working 
committee. 

The  establishment  of  a  separate  country  bankers'  clearing 
house  would  have  led  to  many  inconveniences,  and  Mr.  John 
Lubbock,  now  Lord  Avebury,  submitted  a  plan  for  carrying 
out  a  separate  country  clearing  at  the  clearing  house.  The 
committee  approved  the  plan  and  submitted  it  to  the  country 
bankers'  committee,  who  also  gave  their  approval. 

Thus  was  instituted  at  the  Bankers'  Clearing  House  the 
country  clearing,  which  more  than  all  else  has  brought  about 
the  almost  universal  use  of  checks  in  England,  to  the  exclu- 
sion of  notes  and  coin. 

Mr.  Lubbock's  scheme  was  so  well  thought  out  that  from 
its  initiation  to  the  present  time  the  rules  have  had  to  be  only 
very  slightly  modified. 

In  1864  the  Bank  of  England  entered  the  clearing  house 
to  clear  on  one  side  only,  the  outside,  for  though  the  bank 
presents  to  the  clearing  bankers  at  the  clearing  house  all  checks 
payable  by  them,  all  checks  and  bills  drawn  or.  the  bank  are 
presented  by  the  clearing  bankers  at  the  bank  itself,  and  the 
proceeds  placed  to  the  credit  of  each  bank's  account.  At  the 
same  time  the  governor  of  the  Bank  of  England  was  made 
ex  officio  a  member  of  the  committee  of  clearing  bankers. 
After  1864  few  changes  were  made  in  the  working  of  the 
clearing  house,  the  volume  of  the  country  and  town  clearings 
increased  greatly,  but  the  house  proved  capable  of  meeting 
any  increase. 

Friction  between  the  old  private  bankers  and  the  joint-stock 
banks  grew  less  as  amalgamations  and  absorptions  increased, 
and  before  many  years  the  committee  of  London  clearing 
bankers  and  joint-stock  banks  committee  amalgamated,  it  be- 
ing agreed,  as  a  condition  of  the  joint-stock  banks  committee 
ceasing  to  exist,  that  all  the  banks  would  abide  by  the  ruling 
of  the  committee  as  to  the  rate  of  deposit  at  seven  days' 
notice.  Henceforth,  every  bank  in  the  clearing  house  was 
entitled  to  have  one  representative  on  the  committee.  Such 


378  CLEARING  HOUSES 

representatives  have  hitherto  been  chosen  solely  from  the  board 
or  the  partners  and  are  nominated  by  their  banks  and  formally 
elected  by  the  committee.  The  committee  elects  its  own  chair- 
man, vice-chairman,  and  honorary  secretary.  This  commit- 
tee meets  regularly  on  the  first  Thursday  in  each  month, 
Thursday  being  the  day  on  which  the  Bank  of  England  in 
normal  times  makes  any  alteration  in  the  bank  rate  of  dis- 
count, but  it  may  be  summoned  by  requisition  at  any  time  and 
meets  automatically  should  the  bank  rate  be  altered,  since  this 
governs  the  rate  of  deposit  allowed  by  the  bankers. 

The  committee  has  full  power  over  all  clearing  house  mat- 
ters, and  from  the  importance  of  the  banks  who  compose  the 
clearing  house  its  opinion  carries  very  great  weight  on  all  mat- 
ters in  the  banking  world.  It  is,  however,  controlled  only  by 
the  mutual  agreement  of  its  members ;  and  the  decision  of  the 
majority  of  its  members,  though  followed  loyally,  is  never 
used  with  any  ultimate  power  of  compulsion  in  matters  affect- 
ing banking  in  general. 

In  1907  a  third  clearing,  the  Metropolitan,  \vas  established. 
Hitherto,  with  the  exception  of  one  or  two  city  offices  which 
were  included  in  the  tow*n  clearing,  the  collection  of  drafts  on 
London  branches  of  the  clearing  banks  had  been  effected  by 
the  post  and  by  the  sending  out  of  walk  clerks  by  each  bank ; 
but  in  1907  it  was  determined  to  do  away  with  such  means 
of  collection  as  far  as  possible  and  to  collect  the  branch  checks 
through  the  clearing  house.  This  proved  so  successful  that 
the  West  End  banks  were  approached  the  following  year,  and 
with  one  exception  readily  consented  to  come  into  the  new 
plan  by  which  their  clearing  agents  had  delivered  to  them  at 
the  Metropolitan  clearing  all  checks  drawn  upon  them.  This 
clearing  is  the  first  clearing  made  each  morning  and  is  han- 
dled so  expeditiously  that  even  the  most  distant  London 
branches  get  their  checks  almost  earlier  than  under  the  old 
system.  They  have,  therefore,  plenty  of  time  to  go  through 
them  and  to  make  returns  of  any  checks  that  cannot  be  paid 
in  time  for  such  return  checks  to  reach  the  clearing  house 
early  in  the  afternoon.  There  are  now  over  330  banks  and 
branches  using  this  clearing. 

For  the  better  defining  of  the  three  clearing  areas  —  town, 


PROVINCIAL  CLEARINGS  379 

metropolitan,  and  country  —  the  letters  T  M  C  have  been 
placed  in  the  corner  of  all  bank  checks.  From  February  19, 
1907,  the  date  of  the  initiation  of  the  Metropolitan  Clearing, 
up  to  December  31  of  that  year,  £482,227,000  was  paid  in  this 
clearing,  while  for  the  year  1908  the  total  was  £647,842,000, 
as  compared  with  the  town  clearing  total  for  that  year  of 
£10,408,254,000  and  the  country  total  of  £1,064,266,000,  mak- 
ing in  all  a  grand  total  of  £12,120,362,000,  which  figures, 
vast  as  they  are,  were  a  decrease  of  £610,031,000  on  the  total 
£12,730,393,000  for  the  previous  year,  I9O7-1  The  work  en- 
tailed by  such  vast  figures  as  these  could  scarcely  have  been 
dealt  with  by  hand  alone,  but  by  the  installation  of  adding 
machines  the  work  is  easily  and  quickly  done. 

It  must  not  be  thought  that  all  checks  on  London  are  pre- 
sented through  the  clearing  house,  for  checks  on  the  London 
branches  of  the  Scotch  banks  and  of  the  colonial  and  foreign 
banks  are  still  presented  over  the  counter. 

Moreover,  though  it  is  mutally  understood  between  the 
clearing  banks  that  checks  on  each  other  will  only  be  pre- 
sented through  the  clearing  house,  this  agreement  has  no  legal 
binding. 

Two  exceptions  are  continually  made ;  documents  or  goods 
have  to  be  taken  up  against  cash,  and  the  owner  before  part- 
ing wishes  to  be  certain  of  his  money.  In  this  case  the  pre- 
senting banker  either  presents  his  check  for  marking  —  that 
is  to  say,  the  paying  banker  having  ascertained  from  his  cus- 
tomer's account  that  there  is  sufficient  money  thereon,  marks 
the  check  for  payment,  which  has  the  same  effect  as  if  the 
banker  had  accepted  it;  or,  as  is  becoming  more  usual,  the 
paying  banker  gives  one  of  his  own  drafts  on  the  Bank  of 
England  in  exchange  for  the  check. 

PROVINCIAL   CLEARINGS 

Besides  the  London  clearing  house,  which  is  an  irregular 
building  of  no  architectural  features  whatever,  there  are  eight 
provincial  clearing  houses  in  England  —  Birmingham,  Bristol, 

1  [For  the  five  years  1910-14,  the  total  clearings  of  the  London  Clearing 
House  were  in  the  neighborhood  of  £15,000.000,000  per  annum  of  which 
the  Town,  Metropolitan,  and  Country  Clearings  were  about  86,  5.5,  and 
8.5  per  cent.,  respectively.] 


380  CLEARING  HOUSES 

Leeds,  Leicester,  Liverpool,  Manchester,  Newcastle,  and  Shef- 
field.1 

Two  only  of  these  clear  over  £100,000,000  in  the  year. 
Manchester  cleared  £320,296,332  in  1907,  with  an  average 
weekly  total  of  £6,159,545  and  an  average  daily  total  of 
£1,039,923,  and  Liverpool  £196,325,829.  The  others  cleared 
in  the  same  year  from  £12,000,000  to  £61,000,000.  Small 
figures,  indeed,  compared  with  London,  where  the  highest 
total  paid  on  any  one  day  was,  in  1907,  £106,703,000.  In 
1908  the  highest  total  paid  in  one  day  in  the  London  clearing 
was  £85,833,000  and  the  lowest  £24,903,000. 

In  London,  as  in  the  provincial  places,  the  object  of  the 
clearing  house  is  primarily  the  convenience  of  exchange  of 
checks,  not  the  regulation  of  banking,  and  little  is  regulated 
save,  perhaps,  the  rate  of  interest  to  be  paid, on  deposits  at 
seven  days'  notice. 

In  these  days,  too,  when  the  tendency  is  strong  for  amalga- 
mation, the  local  banks  are  dwarfed  by  their  gigantic  com- 
petitors, with  their  branches  in  many  counties  and  head  offices 
in  London,  with  the  result  that  London  each  year  controls 
more  of  the  banking  in  England  and  the  provincial  clearings 
cease  more  and  more  to  be  under  local  control,  but  are  con- 
trolled by  their  London  head  offices. 

This  may,  if  the  present  tendency  of  amalgamation  con- 
tinues,2 result  in  the  committee  of  London  clearing  bankers 
becoming  an  important  controlling  body,  but  that  time  is  not 
yet  at  hand,  and  though,  as  \ve  have  said,  an  expression  of 
opinion  on  the  part  of  the  committee  carries  very  great  weight, 
yet  anything  like  dictation  would  very  properly  be  resented 
by  the  important  and  old-established  banks  in  both  London 
and  the  provinces  that  are  outside  the  clearing  house. 

1  [The  approximate  number  of  clearing  houses  outside  of  London,  in 
England,  in   1915  is  twelve,  but  these  are  used  only  for  local  clearings. 
In  addition  most  of  the  towns  in  England  and  Wales  have  a  local  exchange 
which  is  a  clearing  on  a  small  scale.] 

2  This  tendency  has  continued  as  to  both  the  joint-stock  and  private 
banks. —  EDITOR. 


CHAPTER  XX 

STATE  BANKS  AND  TRUST  COMPANIES  SINCE  THE 
PASSAGE  OF  THE  NATIONAL  BANK  ACT 

1  THE  banking  institutions  of  the  United  States  other  than 
national  banks  are  ordinarily  classified  into  (a)  state  banks, 
(b)  trust  companies,  (c)  stock  savings  banks,  (d)  mutual 
savings  banks,  and  (e)  private  banks.  The  following  pages 
deal  with  two  of  these  classes,  viz.,  state  banks  and  trust  com- 
panies. It  will  be  desirable  at  the  outset  to  distinguish  them 
from  the  other  classes,  and  to  outline  the  history  of  legisla- 
tion concerning  them  since  1865. 

The  term  "  state  bank  "  has  been  used  in  the  United  States 
in  several  different  senses ;  but  whatever  the  variance  in  mean- 
ing, such  banks  have  always  had  one  common  characteristic 
—  incorporation  under  state  authority.  In  the  bank  reports 
of  some  of  the  States,  private  banks  are  not  distinguished  from 
state  banks.  This  is  due  to  the  fact  that  in  these  States  in- 
corporated and  unincorporated  banks  are  subject  to  the  same 
regulation.  A  private  bank,  however,  is  an  unincorporated 
bank. 

Not  all  banking  institutions  incorporated  by  the  States  are 
state  banks.  Mutual  savings  banks,  stock  savings  banks,  and 
trust  companies  are  also  corporations  organized  under  state 
laws  or  charters  granted  by  state  legislatures.  The  distinc- 
tion between  mutual  savings  banks  and  state  banks  is  clear. 
Mutual  savings  banks  do  not  have  a  capital  stock  and  do  not 
carry  on  a  discount  and  deposit  business  —  i.  e.,  they  do  not 
discount  commercial  paper,  and  do  not  receive  demand  de- 
posits payable  on  check.  State  banks,  on  the  other  hand,  have 
a  capital  stock  and  carry  on  a  discount  and  deposit  business. 

Adapted  from  George  E.  Barnett,  State  Banks  and  Trust  Companies 
since  the  Passage  of  the  National  Bank-Act,  Publications  of  the  National 
Monetary  Commission.  Senate  Document  No.  659,  6ist  Congress,  Second 
Session. 

38i 


382  STATE  BANKS  AND  TRUST  COMPANIES 

Many  state  banks,  however,  receive  also  savings  deposits. 
The  line  of  demarcation  between  state  banks  and  stock  savings 
banks  is  much  less  definitely  marked.  Both  state  banks  and 
stock  savings  banks  have  a  capital  stock.  Stock  savings  banks 
are  primarily  savings  banks,  and  many  of  them  do  not  do  a 
discount  and  deposit  business,  but  confine  themselves  to  the 
savings  bank  business.  But  in  several  States  the  distinction 
between  state  banks  and  stock  savings  banks  is  of  the  most 
unsubstantial  character,  since  the  stock  savings  banks  carry 
on  the  business  of  a  commercial  bank,  receiving  demand  de- 
posits payable  on  check,  and  discounting  commercial  paper. 
Finally,  the  distinction  between  state  banks  and  trust  com- 
panies is  not  exactly  the  same  in  any  two  of  the  States. 

"  State  banks  "  then,  as  the  term  is  used  in  the  following 
pages,  are  banks  of  discount  and  deposit  (as-  distinguished 
from  savings  banks,  mutual  and  stock)  incorporated  by  one 
of  the  States  or  Territories  (in  contrast  with  private  banks, 
which  are  unincorporated,  and  with  national  banks,  which  are 
organized  under  the  national-bank  act).1 

In  1860  there  were  in  the  United  States  1,562  state  banks. 
Owing  to  the  repressive  influence  of  the  national-bank  act, 
hastened  in  its  effect  by  the  10  per  cent,  tax  on  state-bank 
notes,  the  number  of  state  banks  had  by  1868  fallen  to  247. 
One  result  of  this  decline  in  the  number  and  importance  of 
state  banks  was  the  cessation  of  state  banking  legislation. 
The  old  laws  regulating  state  banks  of  issue  were  swept  away 
by  code  revisions,  or  remained  obsolete  and  unchanged  on  the 
statute  books. 

.  The  number  of  state  banks  began  to  increase  about  1870. 
In  a  few  States  old  banking  laws  intended  for  the  regulation 
of  banks  of  issue  hampered  their  development,  but  in  the  re- 
maining States  they  were  left  for  a  considerable  period  almost 
entirely  without  regulation.  As  late  as  1892,  in  his  digest  of 
the  state  statute  law,  Mr.  Stimson  said : 

It  seems  unnecessary  to  incorporate  the  state  banking  laws  in 
this  edition.  Nearly  all  the  States,  except  the  newer  States  and 
Territories,  have  special  chapters  in  their  corporation  acts  concern- 

1  [At  least  one  savings  bank  has  gained  admittance  to  the  Federal  Re- 
serve System  as  a  "state"  bank.] 


EVOLUTION  OF  THE  TRUST  COMPANY  383 

ing  banks  and  moneyed  institutions,  but  these  chapters  are  usually 
of  old  date,  and  have  practically  been  superseded  for  so  long  a  time 
by  the  national  banking  laws  that  they  have  become  obsolete  in  use 
and  form. 

The  increasing  attention  paid  in  recent  years  by  the  state 
legislatures  to  the  regulation  of  the  state  banks  has  been  partly 
due  to  the  rapid  growth  of  the  banks  in  numbers  and  in  finan- 
cial importance;  but  it  is  to  be  accounted  for  primarily  by 
a  change  of  view  as  to  the  purpose  of  banking  regulation. 
The  antebellum  state-bank  regulations  were  intended  to  secure 
the  safety  of  the  bank  note.  Although  the  depositor  was  pro- 
tected by  many  of  the  regulations,  this  protection  was  purely 
incidental.  The  view  that  note-issuing  banks  alone  required 
governmental  regulation  persisted  for  a  considerable  time 
after  the  passage  of  the  national-bank  act.  Since  the  national 
banks  had  a  monopoly  of  the  issue  of  bank  notes,  the  regula- 
tion of  state  banks  was  considered  needless.  As  the  im- 
portance of  note  issue  as  a  banking  function  decreased,  bank- 
ing regulation,  as  seen  in  the  national-bank  act,  began  to  be 
considered  desirable  as  a  protection  to  depositors. 

THE  EVOLUTION  OF  T.HE  TRUST  COMPANY 

With  the  exception  of  the  power  to  issue  notes,  which  would 
be  unavailable  because  of  the  tax  on  note  issue,  the  powers  of 
the  state  banks  of  to-day  are  essentially  the  same  as  the  pow- 
ers of  the  state  banks  which  were  in  operation  before  the 
Civil  War.  On  the  other  hand,  the  trust  company  is  a  new 
type  of  banking  institution,  the  functions  of  which  are  even 
yet  not  clearly  defined.  A  great  part  of  the  legislation  with 
reference  to  trust  companies,  therefore,  has  had  to  do  with 
defining  the  powers  of  these  corporations. 

The  early  laws  for  the  incorporation  of  trust  companies 
show  the  widest  differences  of  opinion  with  regard  to  their 
field  of  operation.  The  one  point  of  agreement  appears  to 
have  been  the  idea  that  a  corporation  could  administer  trusts 
more  advantageously  and  safely  than  an  individual.  But  the 
companies  in  all  the  States  were  given  additional  powers  more 
or  less  closely  connected  with  their  trust  powers.  Some  of 


384  STATE  BANKS  AND  TRUST  COMPANIES 

the  companies,  chiefly  the  very  early  ones,  were  empowered 
to  insure  lives  and  to  grant  annuities.  In  a  considerable  num- 
ber of  States  the  companies  were  authorized  to  insure  the 
fidelity  of  persons  in  positions  of  trust  and  in  some  States 
to  insure  titles  to  land.  Almost  all  the  companies  were  em- 
powered to  do  a  safe-deposit  business.  Among  these  powers 
there  was  a  certain  apparent  connection.  The  power  to  in- 
sure the  fidelity  of  trustees,  administrators,  and  executors 
seemed  a  natural  addition  to  the  powers  of  a  company  which 
might  act  in  such  capacities.  Similarly,  it  appeared  that  the 
business  of  insuring  titles  to  land  was  one  \vhich  could  be 
most  economically  conducted  by  a  corporation  which,  in  its 
capacity  of  trustee,  would  be  a  large  owner  of  real  estate. 

One  other  power  was  given  to  practically  all  the  companies 
—  the  power  to  receive  deposits  of  money  in  trust.  The  fol- 
lowing quotation  from  the  Report  of  the  Massachusetts  Com- 
missioners of  Savings  Banks  for  1871  shows  the  use  which 
it  was  expected  would  be  made  of  this  power : 

The  trust  company  in  Worcester  and  the  New  England  Trust 
Company  in  Boston,  both  in  successful  operation,  are  the  first  of 
such  corporations  established  in  this  State.  They  were  incorporated 
after  a  very  careful  investigation  by  the  legislature,  with  power  to 
hold  money  in  trust,  and  so  restricted  in  making  loans  and  invest- 
ments as  to  afford  the  safety  which  the  character  of  their  business 
requires.  A  similar  institution  will  soon  be  organized  in  Northamp- 
ton, and  others  are  contemplated.  They  are  well  calculated  to  pro- 
mote public  interests  by  affording  to  the  owners  of  capital  not 
engaged  in  business  many  of  the  advantages  secured  by  our  savings- 
bank  system  for  the  savings  of  labor. 

The  development  of  the  trust  company  as  reflected  in  the 
legislation  with  reference  to  its  powers  shows  two  main 
tendencies :  ( I )  The  companies  have  to  a  very  large  extent 
given  up  the  insuring  of  the  fidelity  of  persons  in  positions  of 
trust  and  the  guaranteeing  of  land  titles.  (2)  They  have 
largely  increased  their  banking  activities. 

i.  In  some  States  which  formerly  authorised  trust  com- 
panies to  insure  the  fidelity  of  persons  in  positions  of  trust, 
or  to  guarantee  titles  to  real  estate,  the  more  recent  laws  do 
not  permit  the  combination  of  such  business  with  the  business 
of  a  trust  company. 


EVOLUTION  OF  THE  TRUST  COMPANY  385 

The  fidelity  insurance  business  during  the  past  twenty  years 
has  been  largely  concentrated  in  the  hands  of  a  comparatively 
small  number  of  companies  which  have  agencies  in  all  parts 
of  the  country  and  which  do  not  undertake  a  trust  or  bank- 
ing business.  The  elimination  of  fidelity  insurance  from  the 
functions  of  the  trust  company  has  not  been  chiefly  or 
even  largely  due  to  adverse  legislation,  but  to  the  nature  of 
the  fidelity  insurance  business.  The  most  successful  conduct 
of  that  business  appears  to  require,  like  other  kinds  of  insur- 
ance, that  the  risks  shall  be  numerous  and  widely  distributed. 
These  conditions  are  best  met  by  companies  which  carry  on 
business  in  many  different  places. 

For  the  most  economical  conduct  of  the  title  insurance 
business  an  expensive  plant  is  necessary.  The  business  in 
each  city  tends  therefore  to  fall  into  the  hands  of  a  single 
company,  which  ordinarily  finds  it  profitable  to  devote  itself 
entirely  to  the  one  kind  of  business.  At  the  present  time, 
only  a  very  small  part  of  the  trust  companies  in  the  United 
States  insure  titles  to  land. 

2.  The  second  great  tendency  in  the  development  of  the 
powers  of  the  trust  company  —  the  enlargement  of  its  bank- 
ing powers  —  has  also  been  primarily  an  economic  develop- 
ment and  not  one  due  to  legislative  design.  As  has  already 
been  noted,  the  early  trust  companies  ordinarily  had  power 
to  receive  trust  deposits  and  to  loan  money.  Some  such  pow- 
ers were  necessary  for  the  exercise  of  their  trust  functions. 
The  opportunity  to  enlarge  the  banking  powers  of  the  com- 
panies lay  in  the  difficulty  of  distinguishing  clearly  between 
the  powers  which  it  was  intended  to  confer  upon  the  trust 
companies  and  the  banking  powers  possessed  by  state  and 
national  banks. 

In  the  greater  number  of  the  States  the  wording  of  the 
sections  conferring  powers  to  do  a  trust  business  was  such 
that  the  trust  companies  were  either  held  by  the  courts  to  be 
empowered  to  do  a  banking  business,  or,  if  the  power  to  do 
such  business  seemed  not  to  be  granted,  were  able  by  some 
change  in  the  method  of  doing  the  kind  of  banking  business 
in  question  to  bring  it  within  the  powers  actually  conferred. 
In  Missouri,  for  instance,  since  1885  trust  companies  have 


386  STATE  BANKS  AND  TRUST  COMPANIES 

been  empowered  to  "  receive  money  in  trust  and  to  accumu- 
late the  same  at  such  rate  as  may  be  obtained  or  agreed  upon 
or  to  allow  such  interest  thereon  as  may  be  agreed."  The 
supreme  court  of  Missouri  in  construing  the  power  thereby 
conferred  has  held  that  a  trust  company  can  take  only  interest- 
bearing  deposits,  but  that  such  deposits  may  be  demand  de- 
posits payable  on  check.  The  rate  of  interest  may,  however, 
be  nominal. 

In  other  States  the  trust  companies  have  attained  legal 
recognition  of  their  banking  powers  by  slow  steps.  The  his- 
tory of  the  Pennsylvania  trust  companies  affords  an  illustra- 
tion. In  the  Pennsylvania  general  corporation  act  of  1874 
no  provision  was  made  for  the  formation  of  trust  companies, 
but  provision  was  made  for  the  incorporation  of  title-insurance 
companies.  By  an  amendment  to  the  corporation  act  in  1881 
title-insurance  companies  with  a  capital  of  at  least  $250,000 
were  given  trust  and  fidelity-insurance  powers;  but  it  was 
expressly  provided  that  such  companies  were  not  authorized 
thereby  to  do  a  banking  business.  In  1885  the  trust  com- 
panies were  given  the  power  to  receive  upon  deposit  for  safe- 
keeping valuable  property  of  every  description,  and  in  1895 
trust  companies  were  given  power  to  "  receive  deposits  of 
money  and  other  personal  property  and  to  issue  their  obliga- 
tions therefor  .  .  .  and  to  loan  money  on  real  and  personal 
securities."  In  1900  the  United  States  circuit  court  of  Penn- 
sylvania, decided  that  Pennsylvania  trust  companies  might 
legally  receive  demand  as  well  as  time  deposits.  Pennsyl- 
vania trust  companies  apparently  even  now  cannot  discount 
commercial  paper,  but  they  may  loan  on  it  as  collateral  and 
may  purchase  it  from  the  holder. 

The  States  in  which  the  banking  powers  of  the  trust  com- 
panies have  been  most  narrowly  restricted  are  Iowa,  Michigan, 
Nebraska,  and  Wisconsin.  In  Nebraska  a  trust  company  can- 
not do  a  banking  business.  In  Iowa  trust  companies  cannot 
do  a  banking  business  except  that  they  may  receive  time  de- 
posits and  issue  drafts  on  their  depositories.  In  Michigan 
trust  companies  are  expressly  forbidden  to  do  "  a  general 
banking  business."  The  Michigan  commissioner  of  banking 
in  his  report  for  1906  complained,  however,  that  the  law  was 


EVOLUTION  OF  THE  TRUST  COMPANY  387 

not  clear  as  to  the  banking  powers  of  the  companies.  In 
Minnesota  the  trust  companies  may  receive  trust  deposits,  but 
may  not  "  engage  in  any  banking  business  except  such  as  is 
expressly  authorized  for  such  a  corporation."  In  Wisconsin 
the  extent  of  the  power  of  trust  companies  to  receive  deposits 
was  much  debated  until  1909,  when  the  legislature  provided 
for  the  incorporation  of  "  trust-company  banks,"  which  have 
power  to  receive  time  and  savings  deposits,  but  do  not  have 
power  to  receive  deposits  subject  to  check. 

The  result  of  the  two  tendencies  described  above  —  the 
elimination  of  the  insurance  powers  of  the  trust  company  and 
the  addition  of  banking  powers  —  has  gradually  standardized 
the  powers  of  the  trust  company,  until  at  the  present  time  the 
trust  company,  as  it  appears  in  the  corporation  laws  of  most 
of  the  States,  may  be  fairly  well  defined  as  a  bank  which  has 
power  to  act  in  the  capacity  of  trustee,  administrator,  guardian, 
or  executor. 

In  a  number  of  States  the  legislation  concerning  trust  com- 
panies deals  with  them  explicitly  from  this  standpoint.  The 
Illinois  bank  act  of  1887  provided  that  any  bank  might  have 
power  to  execute  trusts  by  complying  with  the  trust-company 
law.  In  Alabama  and  Tennessee  any  state  bank  may  be  ap- 
pointed and  may  act  as  an  executor,  administrator,  receiver, 
or  guardian.  In  Mississippi  any  bank  with  a  paid-up  capital 
of  $100,000  may  do  a  trust-company  business.  In  Georgia 
any  trust  company  may  acquire  banking  powers  by  complying 
with  the  laws  regulating  banks.  In  Texas  banks  may  acquire 
trust-company  powers.  The  same  tendency  is  shown  in  the 
important  banking  laws  enacted  in  Ohio  in  1905  and  Cali- 
fornia in  1909. 

The  gradual  change  from  the  view  that  the  trust  company 
is  an  institution  of  markedly  different  character  from  the  ordi- 
nary bank  of  discount  and  deposit  to  the  view  that  the  trust 
company  is  merely  a  bank  exercising  functions  additional  to 
those  exercised  by  the  majority  of  banks  has  been  the  chief 
influence  in  determining  the  form  of  the  legal  regulations  im- 
posed upon  trust  companies.  As  long  as  the  older  view  ob- 
tained, the  regulations  concerning  trust  companies  were  widely 
different  from  those  imposed  upon  banks ;  but  as  the  trust  com- 


388  STATE  BANKS  AND  TRUST  COMPANIES 

pany  has  increased  both  the  scope  and  amount  of  its  banking 
business,  the  regulation  of  the  banking  business  of  the  trust 
company  has  tended  to  become  assimilated  to  the  regulations 
imposed  upon  state  banks. 


INCORPORATION 

Since  1865  state  banks  and  trust  companies  have  been  incor- 
porated by  the  use  of  one  of  three  methods:  (i)  By  special 
charter;  (2)  under  the  "business  incorporation  law";  (3) 
under  the  general  banking  law.  Not  very  many  of  the  States 
have  used  consecutively  all  three  methods,  for  the  special  char- 
ter and  the  "  business  incorporation  law  "  were  used  contem- 
poraneously in  different  sections  of  the  country.  Both  have 
given  place,  in  the  great  mass  of  States,  to  the  general  banking 
law.  From  1865  to  1875  probably  the  greater  number  of  the 
banks  formed  were  incorporated  under  special  acts;  from  1875 
to  1887  incorporation  under  the  "  business  incorporation  law  " 
was  the  prevailing  method,  and  since  then  the  general  bank- 
ing law  has  become  the  almost  universal  method  of  incorporat- 
ing banks  and  trust  companies. 

CAPITAL  AND  SURPLUS  REQUIREMENTS 

When  the  States  began  to  give  attention  to  the  regulation  of 
the  banking  business  the  question  of  capital  received  immedi- 
ate attention.  The  national-bank  act  and  the  banking  laws  in 
New  York  and  the  Middle  West  which  had  survived  from  the 
antebellum  period  contained  provisions  concerning  the  amount 
and  payment  of  capital.  A  requirement  with  regard  to  capital 
was  recognized  as  the  central  point  in  any  system  of  bank  regu- 
lation. The  capital  stock  is  a  buffer  interposed  between  the 
bank's  creditors  and  losses  which  the  bank  may  suffer.  If 
there  is  no  capital,  losses  may  fall  directly  on  the  creditor,  and 
the  larger  the  capital  stock,  other  things  being  equal,  the  less 
the  likelihood  of  loss  to  the  depositor. 

The  States  and  Territories  may  be  divided  roughly  into  two 
groups  according  to  the  amount  of  the  smallest  permissible 
capital  for  state  banks : 


CAPITAL  AND  SURPLUS  REQUIREMENTS  389 

1.  In  the  Eastern  States  and  the  more  easterly  of  the  Middle 
Western  States,  the  banking  laws,  with  one  exception,  require 
that  banks  shall  have  a  capital  of  at  least  $25,000. 

2.  In  the  other  sections  of  the  United  States  banks  in  most 
of  the  States  are  incorporated  with  a  capital  as  small  as  $10,- 
ooo,  although  in  a  few  of  these  States  the  smallest  permissible 
capital  is  $15,000,  $20,000,  $25,000,  and  $30,000,  and  in  one, 
North  Carolina,  it  is  $5,000. 

The  amount  of  capital  required,  except  in  a  few  States,  is 
not  a  uniform  amount,  but  is  graded,  usually  according  to  the 
size  of  the  city  in  which  the  bank  is  located.  In  29  of  the  37 
States  and  Territories  which  require  under  a  general  law  a 
specified  amount  of  capital  for  the  incorporation  of  state  banks 
the  amount  of  capital  is  thus  graded.  The  grading  of  the 
amount  of  capital  required  according  to  the  population  of  the 
place  in  which  a  bank  is  located  has  been  chiefly  due  to  the 
desire  to  bring  about  some  adjustment  between  the  capital  of 
each  bank  and  the  volume  of  its  business.  It  is  assumed  that 
the  larger  the  business  of  the  bank  the  greater  the  chance  of 
its  suffering  large  losses  and  the  larger  the  capital  necessary 
to  protect  its  depositors  against  loss.  It  is  also  assumed  that 
the  size  of  the  city  in  which  it  is  located  is  a  rough  index  of 
the  volume  of  business  done  by  a  bank.  Under  many  of  the 
state  banking  laws  the  grades  are  very  numerous.  The  minute 
gradation  of  the  capital  requirements  found  in  many  of  the 
state  banking  laws  is  due  to  the  desire  to  encourage  the  forma- 
tion of  banks  in  the  smaller  cities  and  towns,  for  it  is  to  be 
noted  that  in  the  greater  part  of  the  state  laws  the  grades  are 
not  numerous  for  the  larger  places. 

Obviously,  if  any  law  requiring  a  minimum  capital  for 
banks  is  to  be  effective,  it  must  provide  specifically  for  the  pay- 
ment either  of  all  the  capital  or  of  a  specified  sum;  otherwise 
the  directors  of  the  bank  may  require  the  payment  of  only  a 
small  part  of  the  capital.  The  provision  in  the  national-bank 
act  concerning  the  payment  of  capital  has  been  the  model  for 
similar  provisions  in  the  banking  laws  of  a  large  number  of 
the  States.  Many  of  the  state  banking  laws  likewise  contain 
the  same  provision  as  the  national-bank  act  with  reference  to 
surplus. 


390  STATE  BANKS  AND  TRUST  COMPANIES 

In  several  States  the  laws  make  no  provision  with  reference 
to  the  amount  of  capital  required  for  a  trust  company.  In 
Connecticut,  Delaw-are,  New  Hampshire,  and  Vermont,  trust 
companies  are  incorporated  only  under  special  acts  and  the 
amount  of  their  capital  is  determined  in  each  particular  case 
by  the  legislature.  In  Rhode  Island  trust  companies  are  in- 
corporated by  a  board  which  has  power  to  fix  the  terms  of 
incorporation,  including  the  amount  of  capital. 

The  first  general  laws  for  the  incorporation  of  trust  com- 
panies in  the  United  States  required  such  companies  to  have 
a  much  larger  capital  than  that  required  for  banks,  but  the 
later  legislation  shows  a  distinct  tendency  in  the  direction  of 
lowering  the  requirements  in  regard  to  capital.  In  nearly  all 
of  the  States,  however,  the  requirement  for  trust  companies 
is  still  substantially  different  from  that  for  state  banks.  The 
smallest  permissible  capital  for  a  trust  company  ranges  from 
$5,000  in  North  Carolina  to  $1,000,000  in  the  District  of 
Columbia.  The  majority  of  the  States,  which  provide  that 
trust  companies  must  have  a  specified  minimum  capital,  do  not 
permit  the  organization  of  trust  companies  with  a  smaller  capi- 
tal than  $100,000. 

In  only  one  State,  Iowa,  is  the  smallest  permissible  capital 
less  for  trust  companies  than  for  state  banks ;  in  six  States  it 
is  the  same;  in  all  the  others  it  is  larger.  The  accumulation 
of  a  surplus  is  not  required  in  so  many  States  for  trust  com- 
panies as  for  banks. 

LIABILITY  OF  STOCKHOLDERS 

With  the  practical  prohibition  of  the  issue  of  state  bank 
notes  in  1866  and  the  consequent  decrease  in  the  number  of 
state  banks,  the  liability  of  stockholders  in  state  banks  became 
in  nearly  all  of  the  States,  except  where  an  additional  liability 
was  imposed  by  the  constitution,  the  same  as  that  of  stock- 
holders in  ordinary  business  corporations.  Since  1880,  how- 
ever, provisions  imposing  an  additional  liability  on  the  stock- 
holders of  banking  corporations  have  been  placed  in  the  bank- 
ing and  trust-company  laws  of  nearly  all  the  States  in  which 
state  banks  or  trust  companies  have  assumed  any  great  im- 


RESTRICTIONS  ON  LOANS  AND  DISCOUNTS          391 

portance.  In  the  larger  number  of  the  States  and  Territories 
the  liability  is  a  proportionate  one,  and  the  stockholders  are 
responsible  "  equally  and  ratably  and  not  one  for  another." 

The  imposition  of  the  statutory  liability  on  the  stockholders 
of  state  banks  and  trust  companies  has  not  proved  of  great 
service  as  a  protection  to  bank  creditors  against  loss.  As  yet 
little  has  been  accomplished  in  the  way  of  making  the  enforce- 
ment of  the  liability  effective. 

RESTRICTIONS  ON  LOANS  AND  DISCOUNTS 

The  desirability  of  some  legal  limitation  on  the  extent  of 
the  liability  to  a  banking  institution  which  any  one  person, 
firm,  or  corporation  may  incur  is  largely  due  to  the  fact,  that, 
since  the  American  banking  system  is  a  system  of  independent 
banks,  the  resources  of  many  of  the  banks  are  necessarily 
small  in  comparison  with  the  needs  of  some  of  their  customers 
for  loans.  A  large  manufacturing  concern  located  in  a  small 
town  may  very  well  be  able  to  use  all  the  assets  of  the  local 
bank.  If  the  local  bank  were  the  branch  of  a  larger  bank, 
the  mere  fact  that  a  large  loan  was  wanted  by  a  manufacturer 
in  a  small  town  would  be  of  no  significance,  since  the  amount 
of  the  loan  would  be  small  compared  with  the  total  assets  of 
the  bank. 

Moreover,  in  many  banks  a  controlling  interest  is  held  by  a 
person,  firm,  or  corporation  that  is  actively  engaged  in  other 
business  enterprises.  Such  control  is  far  more  likely  to  be 
found  in  small  banks  than  in  large,  and  in  a  system  of  inde- 
pendent banks  than  in  one  of  branch  banks.  One  consequence 
of  the  close  identification  of  interest  thus  brought  about  be- 
tween banking  and  other  business  enterprises  is  the  probability 
that  loans  will  be  made  directly  or  indirectly  to  some  one  bor- 
rower to  an  amount  larger  than  a  proper  distribution  of  risks 
would  justify. 

The  national-bank  act  in  its  original  form  provided  that  the 
total  liabilities  to  any  national  bank  of  any  person,  company, 
corporation,  or  firm  for  money  borrowed  should  not  exceed 
one-tenth  of  the  amount  of  the  paid-in  capital  stock  of  the 
bank.  The  liabilities  of  the  members  of  the  firm  or  company 


392  STATE  BANKS  AND  TRUST  COMPANIES 

were  to  be  included  in  the  liabilities  of  the  firm  or  company. 
It  was  provided,  however,  that  "  the  discount  of  bills  of  ex- 
change in  good  faith  against  actually  existing  values  and  the 
discount  of  commercial  or  business  paper  actually  owned  by 
the  person  negotiating  the  same  "  should  not  be  considered  as 
money  borrowed.  This  section  of  the  national-bank  act  re- 
mained unchanged  until  1906,  when  it  was  amended  so  as  to 
permit  a  single  liability  to  be  contracted  equal  to  one-tenth  of 
the  capital  and  surplus,  instead  of  one-tenth  of  capital  only, 
but  it  wras  also  provided  that  the  liability  should  not,  in  any 
case,  exceed  30  per  cejit.  of  the  capital  stock. 

In  the  banking  laws  of  seven  States  the  limit  on  the  amount 
of  single  liability  is  the  same  as  under  the  national-bank  act. 
The  banking  laws  of  almost  all  the  other  States  permit  a  larger 
amount  to  be  loaned  on  a  single  liability  than -is  permitted  by 
the  national-bank  act. 

In  nearly  all  of  those  States  in  which  trust  companies  have 
acquired  full  banking  powers  the  provision  limiting  the  amount 
of  any  single  liability  applies  to  both  banks  and  trust  com- 
panies. In  only  one  State  or  Territory  —  New  Mexico  —  is 
there  such  a  provision  for  trust  companies  and  none  for  state 
banks.  In  a  few  States  —  Kansas,  Michigan,  Minnesota, 
Missouri,  Montana,  Oklahoma,  New  Jersey,  Nebraska,  and 
Wisconsin  —  there  are  limitations  on  the  amount  of  a  single 
liability  for  banks,  but  none  for  trust  companies. 

LOANS    TO    DIRECTORS    AND    OFFICERS 

In  almost  all  the  banking  institutions  of  the  United  States 
the  directors  or  a  part  of  them  are  actively  engaged  also  in 
other  business  enterprises;  and  in  many  cases  they  borrow 
from  the  banks  or  trust  companies  in  which  they  are  directors. 
Moreover,  in  some  banks  one  or  two  of  the  directors  own  a 
controlling  interest,  and  are  at  the  same  time  large  borrowers. 
The  possibility,  in  such  cases,  that  larger  loans  may  be  made 
than  the  credit  of  those  directors  warrant  is  very  considerable. 
The  national-bank  act  contains  no  provisions  regarding  loans 
to  directors,  but  in  the  laws  of  about  one-half  of  the  States 
attempts  have  been  made  to  devise  rules  which  would  prevent 


RESTRICTIONS  ON  LOANS  AND  DISCOUNTS          393 

the  making  of  loans  to  directors  in  excess  of  the  amount  to 
which  their  credit  entitles  them.  The  requirement  that  loans 
to  directors  shall  be  formally  approved  by  the  board  of  di- 
rectors is  the  one  most  frequently  found.  It  has  been  thought 
that  directors  would  be  reluctant  to  vote  for  excessive  loans 
to  other  directors  if  their  vote  is  to  be  recorded. 


REAL   ESTATE   LOANS 

There  is  no  more  characteristic  difference  between  state 
banking  laws  and  the  national-bank  act  than  the  fact  that, 
in  almost  all  the  States,  state  banks  and  trust  companies 
may  make  loans  on  the  security  of  real  estate,  whereas  na- 
tional banks  are  [were]  prohibited  from  doing  so  [before 
the  passage  of  the  Federal  Reserve  Act].  In  some  States, 
where  the  influence  of  the  example  of  the  national-bank  act 
was  strong  enough  at  the  beginning  of  state-bank  regula- 
tion to  secure  the  insertion  in  the  state  banking  laws  of  the 
prohibition  of  real  estate  loans,  it  has  later  been  found  desir- 
able to  amend  the  laws  in  this  respect.  The  Pennsylvania  gen- 
eral banking  law  of  1878,  for  instance,  did  not  permit  banks 
to  loan  on  real,  estate,  but  was  amended  in  1901,  so  as  to  per- 
mit such  loans  to  be  made.  In  North  Dakota  and  South  Da- 
kota, also,  similar  changes  have  been  made  in  the  banking 
laws.  In  1910  trust  companies  in  all  the  States  and  Terri- 
tories where  incorporated  under  general  laws  were  allowed  to 
loan  on  the  security  of  real  estate.  State  banks  so  incor- 
porated may  also  loan  on  real  estate  in  all  the  States  and  Ter- 
ritories except  New  Mexico  and  Rhode  Island.  In  Rhode 
Island,  however,  banks  may  loan  on  real  estate  part  of  their 
savings  deposits. 

A  few  of  the  state  banking  and  trust-company  laws  contain 
provisions  limiting  the  amount  which  may  be  invested  in  real 
estate  loans. 

Notwithstanding  the  disadvantages  of  real  estate  as  a  con- 
vertible asset,  the  power  to  loan  on  the  security  of  real  estate 
is  a  valuable  one  to  many  of  the  state  banks.1  Many  banks, 
particularly  those  in  the  smaller  towns  and  cities,  if  restricted 

1  According  to  reports  to  the  National  Monetary  Commission  on  April 


394  STATE  BANKS  AND  TRUST  COMPANIES 

to  loans  on  personal  security,  find  it  difficult  to  fully  employ 
their  funds.  There  are  not  sufficient  local  loans  of  this  kind 
to  employ  all  the  funds  of  the  bank;  and  the  amount  not  so 
employed,  if  it  is  to  yield  a  revenue,  must  either  be  invested 
in  outside  commercial  paper  or  deposited  with  banks  in  the 
great  commercial  cities. 

RESERVES 

In  most  of  the  antebellum  state  banking  laws  reserves  were 
required  only  against  note  issue.  In  Ohio,  for  example,  the 
general  banking  law  required  a  reserve  of  30  per  cent.,  against 
circulation,  but  none  whatever  against  deposits.  Several  of 
the  state  banking  laws  which  survived  the  destruction  of  the 
state  bank-note  issue  contained,  however,  provisions  requiring 
banks  to  hold  a  reserve  against  deposits ;  but  in  none  of  these 
States  was  the  increase  in  the  number  of  state  banks  impor- 
tant. In  those  States- in  which  the  state  banks  were  organized 
under  the  "  business  incorporation  laws  "  there  were,  of  course, 
no  reserve  requirements.  Until  1887  a  reserve  was  required 
for  state  banks  in  only  three  States,  Ohio,  Minnesota,  Con- 
necticut, and  in  these  the  required  reserves  were  small.  Even 
since  the  revival  of  state  bank  regulation,  which  began  in 
1887,  the  requirement  of  a  reserve  has  not  been  regarded  in 
many  of  the  States  as  an  important  part  of  the  state  banking 
law. 

The  most  striking  and  important  difference  between  the  re- 
serve required  by  the  national-bank  act  and  the  reserves 
required  by  the  state  banking  laws  is  that  under  the  national- 
bank  act  the  reserve  is  a  percentage  of  "  deposits  "  — i.  e.,  of 
all  deposits  —  while  under  the  banking  laws  of  a  majority  of 
the  States  either  no  reserve  is  required  against  time  or  savings 
deposits,  or  a  smaller  amount  of  reserve  is  required  than 
against  demand  deposits. 

None  of  the  state  banking  laws  require  that  the  reserve  of 
any  class  of  banks  shall  consist  wholly  of  cash  in  bank.  All 
the  laws  permit  balances  in  other  banks  to  be  counted  at  least 

28,  TQOQ,  the  loans  of  all  the  state  banks  in  the  United  States  on  the  se- 
curity of  real  estate  were  20.6  per  cent,  of  their  total  loans  and  dis- 
counts. 


BRANCH  BANKS  395 

as  a  part  of  the  reserve.  There  are  great  differences  among 
the  laws,  however,  with  respect  to  the  amount  which  may  be 
so  counted. 

The  laws  in  all  the  States  leave  the  banks  almost  entirely 
free  to  deposit  their  funds  in  banks  in  the  great  commercial 
centres.  The  strong  economic  pressure  toward  concentration 
is  thus  left  free  to  act  toward  drawing  reserves  into  banks 
located  in  the  reserve  and  central  reserve  cities. 

In  the  greater  number  of  States  which  incorporate  both 
state  banks  and  trust  companies  the  reserve  requirement  is  the 
same  for  both  classes  of  credit  institutions.  Slight  differences 
between  the  requirements  for  trust-company  reserves  and 
those  for  state-bank  reserves  are  chiefly  of  two  kinds.  In  the 
first  place,  the  provisions  for  trust-company  reserves  more  fre- 
quently permit  the  counting  of  bonds  as  a  part  of  reserve; 
secondly,  the  provisions  for  differing  amounts  of  reserve 
against  time  and  demand  deposits. 

In  recent  years  there  has  been  much  complaint  in  some 
States  that  the  reserves  required  for  trust  companies  are  in- 
adequate. 

BRANCH  BANKS 

The  most  characteristic  feature  of  American  banking  is  the 
extent  to  which  the  banks  and  trust  companies  are  independent 
institutions.  The  national-bank  act  makes  no  provision  for 
the  establishment  of  branch  banks  except  in  cases  of  the  con- 
version of  state  banks  which  already  have  branches.  Such 
banks  are  allowed  to  retain  their  branches  on  condition  that 
the  capital  is  assigned  to  the  mother  bank  and  the  branches  in 
definite  proportions,  but  only  a  few  national  banks  have 
branches.  Under  none  of  the  state  banking  laws  has  there 
been  built  up  an  important  system  of  branch  banks.  This  has 
been  partly  due  to  the  very  general  desire  of  each  American 
community,  no  matter  how  small,  to  have  its  bank  managed 
by  its  own  citizens,  and  partly  to  the  fact  that  in  most  of  the 
States  the  establishment  of  branch  banks  is  either  explicitly 
forbidden  or  in  no  way  provided  for  by  law.  In  eight  State 
—  Colorado,  Connecticut,  Mississippi,  Missouri,  Nevadr;, 
Pennsylvania,  Texas,  and  Wisconsin  —  the  opening  of  branch 


396  STATE  BANKS  AND  TRUST  COMPANIES 

offices  is  forbidden  by  specific  enactment.  In  a  large  number 
of  other  States  the  banking  laws  make  no  provision  for  the 
establishment  of  branches,  and  it  has  been  held  in  most  of 
these  States  that  the  opening  of  branch  offices  is  unlawful. 

The  States  in  which  state  banks  and  trust  companies  are 
definitely  permitted  to  have  branches  are  California,  Delaware, 
Florida,  Georgia,  New  York,  Oregon,  Rhode  Island,  Virginia, 
and  Washington.  In  Louisiana,  Maine,  and  Massachusetts 
trust  companies  may  have  branches.  In  Maryland  and  North 
Carolina  branches  are  operated  by  some  banks  and  trust  com- 
panies which  were  chartered  by  special  act.  There  are  in  sev- 
eral of  these  States,  however,  restrictions  on  the  opening  of 
branch  offices.  In  New  York  and  Massachusetts  branches 
may  be  established  only  in  the  city  in  which  the  principal  office 
of  the  bank  or  trust  company  is  located.  In  New  York,  more- 
over, only  banks  located  in  a  city  of  1,000,000  inhabitants  or 
over  may  have  branches;  but  any  trust  company  may  have 
branches.  In  Maine  a  trust  company  may  establish  branches 
only  in  the  county  in  which  it  is  located  or  in  an  adjoining 
county. 

In  nearly  all  the  States  which  permit  banks  or  trust  com- 
panies to  establish  branches  one  or  both  of  two  conditions  are 
imposed.  In  the  first  place,  additional  capital  is  required  for 
each  branch  bank  over  and  above  the  amount  of  the  parent 
bank.  Secondly,  the  establishment  of  a  branch  bank  must  be 
specifically  authorized  by  some  state  official  or  officials. 

The  number  of  branches  of  banks  and  trust  companies  can- 
not exceed  a  few  hundred  in  the  entire  United  States.  Com- 
pared with  the  total  number  of  banks  and  trust  companies  this 
is  a  small  development.  Moreover,  the  most  important  affili- 
ations among  banking  institutions  are  among  those  located  in 
the  same  city.  The  "  chains  "  of  country  banks  possess,  for 
the  most  part,  little  vitality,  and  in  the  total  banking  business 
of  the  country  they  play  an  insignificant  role.  The  great  mass 
of  state  banks  and  trust  companies  are  independent  institu- 
tions. The  most  enduring  affiliations  at  present  existing 
among  the  banking  institutions  are  those  between  a  national 
bank  and  a  trust  company  or  a  state  bank  and  a  trust  com- 
pany. The  comparatively  limited  powers  of  the  national 


BRANCH  BANKS  397 

banks  and  in  some  States  of  the  state  banks  have  made  it  de- 
sirable for  many  of  these  institutions  to  affiliate  trust  com- 
panies with  themselves  in  order  that  desirable  business  may 
not  be  lost. 


FURTHER  REASON  FOR  THE  LACK  OF  BRANCH  BANKS 
IN  THE  UNITED  STATES 

1  It  would  seem  that  there  must  be  a  reason  for  this  pecu- 
liarity [the  small  number  of  branches]  in  the  banking  system 
of  the  United  States.  In  searching  for  this  reason,  the  first 
fact  of  importance  seems  to  be  that,  although  the  organization 
of  branches  has  been  permitted  to  the  non-note-issuing  banks 
in  some  of  the  States,  they  have  not  been  organized,  while  in 
other  countries  they  have  been  established  in  nearly  every  case 
by  note-issuing  banks.  This  seems  at  once  to  indicate  that  in 
places  where  notes  are  the  most  important  medium  of  ex- 
change a  connection  of  some  sort  exists  between  the  issue  of 
notes  and  the  establishment  of  branches. 

The  inducement  to  the  establishment  of  branches  by  banks 
is,  of  course,  the  possibility  of  profit.  But  as  has  already  been 
frequently  pointed  out,  profit  can  be  obtained  only  by  making 
loans.  These  when  greater  than  the  amount  of  the  capital,  as 
it  is  necessary  that  they  should  be,  can  be  made  by  the  loan  of 
funds  left  with  banks  by  others  or  by  the  issue  of  circulating 
notes.  It  is  also  clear  that,  were  the  possibilities  of  loaning 
beyond  the  amount  of  the  capital  wholly  or  chiefly  confined  to 
one  of  these  forms  of  liability  —  the  other  being  unavailable, 
as  in  the  case  of  the  state  bank  notes  whose  issue  is  prohibited 
by  the  10  per  cent,  tax  —  and  were  this  other  form  distasteful 
or  impossible  of  introduction  among  the  community  where  the 
branch  was  to  be  established,  the  motive  for  the  creation  of  the 
branch  would  be  absent.  This  motive  has  been  wanting  in 
many  parts  of  the  United  States.  By  the  laws  of  the  United 
States,  the  issue  of  notes  has  been  made  impossible  to  all  save 
national  banks,  and  the  capital  of  these  banks  has  been  limited 
to  $50,000  as  a  minimum.  Banks  other  than  national  must, 

1  The  Report  of  the  Monetary  Commission  of  the  Indianapolis  Con- 
vention, pp.  377-8.  The  University  of  Chicago  Press.  1898. 


398  STATE  BANKS  AND  TRUST  COMPANIES 

therefore,  be  established  under  state  laws,  some  of  which  have 
permitted  the  organization  of  such  institutions  with  capitals  as 
low  as  $5,000  or  $10,000.  They  can,  however,  make  use  only 
of  deposits  as  a  means  of  loaning  beyond  the  amount  of  their 
capital.  But  deposits  do  not  provide  a  desirable  form  of  cur- 
rency for  use  in  country  districts.  It  follows,  therefore,  that 
the  state-bank  systems  supply  the  deficiencies  of  the  national 
system  only  in  so  far  as  they  furnish  independent  banks  of 
smaller  capital  than  $50,000  ($25,000  since  1900). 

Nor  would  it  have  been  of  material  assistance  had  the  or- 
ganization of  national  banks  of  capitals  smaller  than  $50,000 
been  allowed.  As  the  system  has  worked  out,  the  issue  func- 
tion has  been  a  useless  one.  The  compulsory  deposit  of  bonds 
to  secure  circulation  has  hampered  the  banks  in  exercising  this 
function,  since  the  requirement  to  deposit  bonds  now  cuts  off 
all  profit  arising  from  the  issue  of  notes.  Moreover,  the  rural 
communities  are  those  where  interest  is  highest,  and  hence 
where  notes  can  least  advantageously  be  issued  under  the  pres- 
ent system  of  bond-deposit,  owing  to  the  high  price  of  the 
bonds.  These  difficulties  probably  cannot  be  overcome  by  the 
establishment  of  banks  of  lower  capitals  than  now  exist. 

1  At  the  1910  convention  of  the  Alabama  Bankers'  Associa- 
tion, held  in  Birmingham  in  May,  one  of  the  speakers,  whose 
topic  was  "  State  Banks  and  Their  Branches,"  closed  a  condem- 
natory address  with  the  words :  "  We  believe  the  days  of  the 
branch  bank  are  numbered."  Two  months  later,  at  Coopers- 
town,  Hon.  E.  B.  Vreeland  told  the  bankers  of  New  York 
State,  at  their  convention :  "  No  one  will  ever  live  to  see  the 
day  when  the  branch  banking  system  which  prevails  in  Canada 
and  in  Germany  and  in  England  and  in  France  will  be  toler- 
ated by  the  people  of  the  United  States."  ..."  The  econo- 
mies of  the  branch  banking  system  are  such  that  no  other  sys- 
tem can  live  beside  it.  It  is  just  as  sure  as  the  sun  will  rise 
to-morrow  that  the  branch  banking  system,  if  taken  up  in 
the  United  States,  would  in  the  end  drive  out  of  existence  all 
the  banks  in  every  city  and  town  in  the  country  outside  of  the 

1  Adapted  from  H.  M.  P.  Eckardt,  Branch  Banking  Among  the  State 
Banks,  The  Annals  of  the  American  Academy  of  Political  and  Social 
Science,  Vol.  36,  No.  3,  November,  1910  pp.  626-630. 


NEW  YORK  BANK  ACT  OF  1914  399 

great  financial  centres.  That  is  the  experience  of  the  world." 
If  this  statement  means  anything  it  is  a  confession  that  the 
system  of  local  single-office  banks  is  wasteful  in  operation,  and 
it  seems  to  me  that  it  sets  forth  one  reason  why  branch  banks 
are  inevitable.  When  a  banking  system  is  wasteful  it  is  the 
stockholders,  borrowers,  and  depositors  who  suffer  from  the 
circumstance,  and  as  soon  as  they  realize  the  fact  its  doom  is 
sealed. 

It  should  be  said  here  that  it  is  not  their  economical  opera- 
tion alone  that  has  enabled  the  branch  banks  to  displace  the 
small  local  banks  in  England,  Germany,  and  .France.  The 
branch  institutions  are  cleaner,  more  efficient,  and  they  pro- 
vide better  opportunities  for  the  clerks  and  officers;  they  give 
a  better  and  more  complete  service  to  the  localities  in  which 
they  work.  .  .  .  Another  reason  is  found  in  their  stability 
during  crises.  .  .  . 

THE  NEW  YORK  STATE  BANK  ACT  OF  1914 1 

In  June,  1913,  George  C.  Van  Tuyl,  Jr.,  superintendent  of 
banks  of  the  State  of  New  York,  appointed  a  commission  to 
look  into  the  banking  conditions  of  the  State  and  to  make  a 
thorough  revision  of  the  law  relating  to  banks.  This  com- 
mission conducted  many  public  hearings;  sought  information 
from  banking  experts  in  this  State  and  in  other  States;  made 
a  careful  study  of  private  banking  conditions,  rural  credits, 
and  other  special  banking  problems  of  the  State;  and,  finally, 
on  February  25,  1914,  they  presented  their  report  in  the  form 
of  a  bill  of  some  500  pages.  After  a  good  many  amendments 
had  been  made  to  appease  conflicting  interests,  the  bill  was 
passed  and  became  law  April  16,  1914. 

In  general,  the  new  law  marks  a  decided  improvement  and 
shows  a  commendable  spirit  of  progressiveness.  Its  framers 
believe  that  it  is  a  law  which  may  well  become  the  model  for 
other  States,  and  there  are  some  who  say  that  it  is  without 
question  the  best  balanced  and  most  comprehensive  state  bank- 
ing legislation  which  has  ever  been  enacted. 

*  Adapted  from  Everett  W.  Goodhue,  The  Revision  of  the  New  York 
State  Banking  Laiv,  The  American  Economic  Review,  Vol.  V,  No.  2,  pp. 
413-421. 


400  STATE  BANKS  AND  TRUST  COMPANIES 

The  new  law  was  the  outgrowth  of  the  general  agitation  for 
banking  reform  which  had  swept  over  this  country  following 
the  panic  of  1907.  The  inciting  cause,  however,  was  the  pass- 
age of  the  Federal  Reserve  Act  which  made  it  necessary  to 
revise  the  state  law  so  that  the  state  banks  either  might  join 
the  federal  system  or  be  in  a  position  to  compete  successfully 
against  the  national  banks  of  the  State,  whose  powers  had 
been  considerably  enlarged  by  this  act.  In  part,  the  law  is 
modelled  after  the  federal  act,  and,  in  part,  European  experi- 
ence has  been  drawn  upon. 

Under  the  new  law  the  state  banks  will  have  even  more  im- 
portance in  the  competition  for  banking  business  than  in  the 
past.  From  the  point  of  view  of  banking  power,  the  278 
banks  of  deposit  and  discount  and  trust  companies  have  aggre- 
gate deposits  in  excess  of  those  of  the  479  national  banks  in 
the  sum  of  $2 8 1, 786,000. *  Furthermore,  it  has  been  esti- 
mated that  the  total  resources  of  the  New  York  state  banks 
are  equivalent  to  17  per  cent,  of  the  aggregate  resources  of  all 
banks  in  the  United  States,  both  state  and  national.  Superior- 
ity in  banking  power  is  one  element  in  the  strong  competitive 
position  of  the  state  banks,  and  another  element  is  the  privi- 
leges granted  to  these  banks  under  the  new  law  which,  in 
some  respects,  are  superior  to  those  granted  the  national  banks 
under  the  federal  law.  In  view  of  the  fact  that  the  state  banks 
can  enjoy  either  directly  or  indirectly  most  of  the  advantages 
of  the  federal  system  and  also  that  in  some  particulars  the 
state  law  gives  them  more  liberal  powers,  it  seems  probable 
that  these  banks  will  continue  to  see  an  advantage  in  their 
state  charters;  and  thus  the  amount  of  defection  from  the  state 
system  will  be  negligible. 

More  real  power  has  been  given  to  the  banking  department 
in  the  provisions  of  the  law.  Through  investigation,  authori- 
zation certificates,  and  regular  uniform  reports,  the  superin- 
tendent of  banks  has  more  direct  control  over  the  banks  than 
ever  before.  Besides  the  extension  of  the  supervisory  powers, 
the  penal  provisions  of  the  act  have  been  strengthened  and 
made  more  exacting. 

1  Annual  Report  of  the  Superintendent  of  Banks  of  the  State  of  New 
York,  Jan.  6,  1915,  P-  33- 


NEW  YORK  BANK  ACT  OF  1914 


401 


I.  Features  of  the  act  relating  to  banks  of  deposit  and  dis- 
count and  trust  companies.  The  reserves  required  against  de- 
posits were  reduced  substantially,  and  made  nearly  uniform 
with  those  required  for  national  banks.  The  following  table 
gives  the  percentage  of  reserve  required  and  the  percentage  of 
reserve  on  hand  which  the  new  law  specifies  for  these  banks. 


Banks  of  deposit  and 
discount 
Per  cent,  of  deposits 

Trust  companies 
Per  cent,  of  deposits 

Population 

Required 
reserve 

Reserve 
on  hand 

Required 
reserve 

Reserve 
on  hand 

2,000,000  or  over  

18 

15 

12 

12 
10 

4 

IS 
13 

10 

10 

8 
4  or  3 

1,000,000  —  2,000,000  .. 
Elsewhere  in  the  state 

The  reserve  requirements  are  made  still  more  definite  by  the 
fact  that  the  law  compels  the  banks  to  keep  one-half  at  least  of 
the  reserve  on  hand  in  "  gold,  gold  bullion,  gold  coin,  United 
States  gold  certificates,  or  United  States  notes;  and  the  re- 
mainder in  any  form  of  currency  authorized  by  the  law  of  the 
United  States  other  than  federal  reserve  notes." 

Among  the  powers  granted  to  these  banks  is  the  power  "  to 
accept  for  payment  at  a  future  date,  drafts  drawn  upon  its  cus- 
tomers and  to  issue  letters  of  credit  authorizing  the  holders 
thereof  to  draw  drafts  upon  it  or  its  correspondents  at  sight 
or  on  time  not  exceeding  one  year."  This  clause  gives  a  much 
wider  power  to  the  state  banks  in  the  important  matter  of 
acceptances  than  its  counterpart  in  the  Federal  Reserve  Act. 
In  the  one  case  both  domestic  and  foreign  acceptances  may  be 
made  and  handled  without  stipulation  as  to  aggregate  amount 
and  bearing  maturities  of  one  year  or  less,  while  in  the  other 
case  the  acceptances  are  limited  to  those  arising  out  of  the 
importation  or  exportation  of  goods  with  maturities  not  ex- 
ceeding six  months.  Seemingly,  the  state  banks  have  the 
advantage,  and  to  this  extent  the  state  law. is  superior  to  the 
federal  act. 

One  other  important  forward  step  was  taken  in  relation  to 
this  group  of  banks.  They  are  given  the  privilege  of  estab- 


402  STATE  BANKS  AND  TRUST  COMPANIES 

lishing  branches  outside  the  State  of  New  York,  either  in  the 
United  States  or  in  foreign  countries.  This  privilege  is  quali- 
fied, however,  by  the  provision  that  no  bank  can  establish  such 
branches  tmless  it  has  a  combined  capital  and  surplus  of 
$1,000,000  or  over  and  the  written  approval  of  the  superin- 
tendent of  banks.  Although  the  old  law  permitted  trust  com- 
panies to  establish  branches  in  the  place  where  they  were  in- 
corporated, the  practical  effect  was  to  limit  branch  banking  to 
the  city  of  New  York.  In  this  particular  also  the  state  banks 
have  the  advantage  over  the  banks  in  the  federal  reserve  sys- 
tem which  are  allowed  to  establish  branches  only  in  foreign 
countries. 

2.  Features  relating  to  private  banks  and  bankers.  The 
regulation  of  private  banks  and  bankers  is  an  entirely  new 
departure  in  the  law  of  this  State.  In  the  past  the  banking 
department  had  no  authority  to  supervise  that  relatively  large 
number  of  private  bankers  who  receive  deposits  in  small 
amounts  from  the  wage-earning  classes  while  conducting  in 
connection  therewith  a  mercantile  or  some  other  kind  of  busi- 
ness. 

Mercantile  firms  like  the  Siegel  Company,  by  paying  a  higher 
rate  of  interest  upon  deposits  than  savings  banks,  were  able 
to  obtain  the  savings  of  many  small  depositors.  This  money 
was  invested  in  the  business  and  secured  only  by  the  capital 
stock  of  the  mercantile  establishments.  In  case  the  firm  failed 
there  was  no  security  back  of  these  deposits  but  these  same 
shares  of  stock,  and  so  depositors  were  fortunate  if  they  re- 
ceived in  settlement  even  40  per  cent,  of  their  claims.  Such 
firms  were  not  doing  a  legitimate  banking  business  inasmuch 
as  they  did  not  keep  their  assets  in  liquid  form  and  carried  no 
reserve  against  deposits. 

The  new  act  corrects  this  situation  by  giving  the  banking 
department  authority  to  conduct  independent  investigations 
into  any  violation  of  the  banking  law  by  a  corporation  or  indi- 
vidual. In  the  future  a  corporation  which  is  in  any  way  en- 
gaged in  the  business  of  banking  cannot  hide  under  the  wing 
of  the  general  corporation  law  when  the  banking  department 
sees  fit  to  make  an  investigation  of  its  affairs. 

Some  of  the  specifications  of  this  part  of  the  law  are  all 


NEW  YORK  BANKING  LAW  OF  1914  403 

securities,  property,  and  the  evidences  of  title  thereto  in  which 
the  permanent  capital  and  the  deposits  are  invested  are  to  be 
segregated  and  kept  separate  from  all  other  property  and  as- 
sets of  the  private  banker;  depositors  have  a  prior  lien  on  the 
assets  of  the  private  banker,  in  case  of  insolvency  or  suspension 
of  business;  and,  in  addition,  every  private  banker  must  main- 
tain a  reserve  of  15  per  cent,  against  deposits  in  cities  of  the 
first  class  and  a  reserve  of  10  per  cent,  in  any  other  city,  one- 
tenth  of  which  shall  consist  of  reserve  on  hand  and  the  re- 
mainder may  be  kept  on  deposit  subject  to  call  with  banks 
approved  by  the  superintendent  of  banks.  These  requirements 
will  go  far  toward  preventing  the  recurrence  of  such  disasters 
as  the  Siegel  failure. 

3.  Features  relating  to  co-operative  credit.  Within  the  last 
thirty  years  the  agricultural  methods  of  the  State,  in  harmony 
with  the  agricultural  methods  throughout  the  United  States, 
have  undergone  great  changes.  Scientific  farming,  improved 
machinery,  and  changed  market  conditions  have  brought  new 
problems  in  the  field  of  agricultural  credit.  To-day  agricul- 
ture has  come  to  be  in  a  real  sense  capitalistic  and  has  in  con- 
sequence laid  new  requirements  on  the  credit  structure  of  the 
nation.  Moreover,  the  period  of  large  returns  or  satisfactory 
returns  from  an  extensive  and  rather  careless  cultivation  of 
the  soil,  which  made  possible  an  ignoring  of  unit  cost,  or,  at 
least,  brought  the  farmer  to  minimize  the  importance  of  such 
cost,  has  given  way,  so  far  as  the  successful  farmer  is  con- 
cerned, to  the  careful  estimates  of  cost  and  close  calculations 
of  profits  on  a  narrow  margin  between  unit  cost  and  unit  sell- 
ing price. 

In  the  field  of  cost,  the  rate  at  which  capital  or  money  may 
be  borrowed  is  no  small  factor;  and  with  the  high  rates  pre- 
vailing in  the  United  States  in  comparison  with  those  current 
in  Europe,  the  borrower  in  this  country  who  pledges  his  land 
or  agricultural  products  as  security  for  a  loan  finds  himself  at 
a  disadvantage.  To  meet  this  condition  cheaper  agricultural 
credit  has  been  strongly  urged.  Europe  furnishes  the  exam- 
ple in  her  well-organized  land  banks  and  co-operative  credit 
unions.  Already  Massachusetts  has  a  law  authorizing  co- 
operative organizations  for  furnishing  cheaper  credit  facilities 


404  STATE  BANKS  AND  TRUST  COMPANIES 

to  the  agriculturalist,  and  in  Illinois  there  is  a  "  credit  foncier  " 
which  has  been  in  successful  operation  a  number  of  years. 
New  York  State  has  put  itself  in  line  with  this  growing  move- 
ment to  furnish  ample  and  cheaper  credit  to  the  farmer  and  the 
purchasers  of  real  estate  by  putting  into  the  new  law  provisions 
for  the  establishment  of  a  land  bank  and  co-operative  credit 
unions. 

Sections  421-438  authorize  ten  or  more  savings  and  loan 
associations,  the  aggregate  resources  of  which  shall  not  be  less 
than  $5,000,000,  to  form  a  Land  Bank  of  the  State  of  New 
York.  This  bank  can  "  issue,  sell  and  redeem  debenture  bonds 
secured  by  bonds  and  first  mortgages  made  to  or  held  by  mem- 
ber associations  "  and  "  invest  its  capital  and  other  funds  in 
bonds  secured  by  first  mortgages  on  real  estate  situated  within 
the  territory  in  which  its  members  are  authorized  to  make 
loans."  The  bank  is  not  permitted  to  do  a  general  deposit 
business  or  incur  any  indebtedness  upon  notes  and  bonds  in 
excess  of  twenty  times  the  amount  of  its  capital.  The  deben- 
ture bonds  authorized  by  the  act  are  to  be  issued  in  series  of 
not  less  than  $50,000,  and  may  be  called  on  any  interest  day 
at  1025/2  provided  a  sixty-day  notice  is  given.  Amortization 
payments  upon  mortgages  which  are  given  as  collateral  se- 
curity for  the  debentures  of  the  land  bank  shall  be  sufficient  to 
liquidate  the  debt  in  a  period  not  exceeding  forty  years. 

In  Article  XI  the  law  provides  for  the  establishment  of 
credit  unions.  A  credit  union  may  be  organized  by  any  seven 
or  more  persons  with  a  share  capital  the  par  value  of  which 
shall  not  exceed  $25.  The  objects  of  the  credit  union  are: 
(i)  to  loan  money  in  small  amounts  on  personal  security  or 
in  larger  amounts  on  endorsed  notes  at  rates  not  exceeding 
i  per  cent,  per  month,  inclusive  of  all  charges  incident  to  the 
making  of  such  loans;  (2)  to  receive  the  savings  of  its  mem- 
bers in  payment  of  shares  on  deposit;  (3)  to  borrow  money 
to  an  amount  not  to  exceed  40  per  cent,  of  its  capital ;  (4)  to 
pay  dividends  on  its  share  capital.  As  to  the  method  of  mak- 
ing loans,  the  law  prescribes  that  a  credit  committee  shall  pass 
upon  all  applications  for  loans  which  must  be  made  in  writing 
and  must  state  the  purpose  for  which  the  loan  is  desired  and 
the  security  offered.  No  loan  will  be  made  unless  it  receives 

r 


NEW  YORK  BANKING  LAW  OF  1914  405 

the  unanimous  approval  of  the  members  of  the  committee 
present  at  the  meeting,  provided  always  a  majority  of  the  com- 
mittee is  present. 

With  the  land  bank  acting  as  a  central  clearing  agency  for 
the  local  savings  and  loan  associations  and  the  organization  of 
many  rural  credit  unions  the  problem  of  agricultural  credit 
will  be  largely  solved  for  New  York  State.  This,  however, 
all  hinges  on  the  proper  functioning  of  the  land  bank  and  the 
co-operation  of  the  farmers  in  the  establishment  of  local  credit 
unions.  Agriculturists  as  a  class  are  slow  to  adopt  new  meth- 
ods and  it  may  be  only  after  prolonged  education  that  all  the 
possibilities  of  this  new  legislation  will  be  realized. 


CHAPTER  XXI 
THE  CANADIAN  BANKING  SYSTEM 

1  Financially,  Canada  is  part  of  the  United  States.  Fully 
half  the  gold  reserve  upon  which  its  credit  system  is  based  is 
lodged  in  the  vaults  of  the  New  York  Clearing  House.  In 
any  emergency  requiring  additional  capital  Montreal,  Toronto, 
and  Winnipeg  call  on  New  York  for  funds  just  as  do  St.  Paul, 
Kansas  City,  and  New  Orleans.  New  York  exchange  is  a 
current  and  universal  medium  in  Canada  and  is  in  constant 
demand  among  the  banks.  A  Canadian  wishing  to  invest  in 
securities  that  may  be  quickly  marketed  commonly  turns  to 
the  New  York  market  for  stocks  and  bonds.  Yet  the  Ameri- 
can banker  visiting  in  Canada,  if  he  is  unacquainted  with  the 
history  of  banking  in  his  own  country,  finds  himself  in  a  land 
of  financial  novelties,  for  Canada  has  a  banking  system  unlike 
any  in  operation  in  the  United  States  at  the  present  time. 
Twenty-nine  banks,  known  as  the  "  chartered  banks,"  transact 
all  the  banking  business  of  the  Dominion.  They  have  2,200 
branches,  and  each  may  establish  new  branches  without  in- 
crease of  its  capital  stock.  [At  the  close  of  the  year  1915 
there  were  twenty-two  banks  with  approximately  3,200 
branches.]  They  issue  notes  without  depositing  security  with 
the  Government  and  in  such  abundance  that  no  other  form  of 
currency  in  denominations  of  $5  and  above  is  in  circulation. 
Notwithstanding  the  fact  that  the  notes  are  "  unsecured,"  their 
"  goodness  "  is  unquestioned  among  the  Canadian  people. 

THE  SYSTEM  NOT  NEW 

But  to  the  student  of  the  history  of  banking  in  the  United 
States  there  is  little  that  is  radically  new  in  the  Canadian  sys- 
tem. He  finds  in  it  many  of  the  practices  and  expedients  that 

1  Adapted  from  Joseph  French  Johnson,  The  Canadian  Banking  System, 
Publications  of  the  National  Monetary  Commission,  Senate  Document  No. 
583,  6ist  Congress,  zd  Session. 

406 


THE  SYSTEM  NOT  NEW  407 

were  found  excellent  in  the  United  States  in  the  first  half  of 
the  nineteenth  century,  and  is  almost  persuaded  that  but  for 
the  Civil  War  what  is  now  known  as  the  Canadian  banking 
system  would  everywhere  be  called  the  American  system. 

The  fiscal  exigencies  of  war,  which  have  caused  changes  in 
the  banking  systems  of  most  countries,  have  had  no  influence 
upon  the  development  of  banking  in  Canada.  During  the  first 
half  of  the  nineteenth  century  the  commercial  and  financial 
interests  of  Canada  and  the  United  States  were  comparatively 
intimate  and  the  financial  institutions  of  both  countries  de- 
veloped on  similar  lines.  The  safety-fund  system,  first  intro- 
duced in  the  State  of  New  York  in  1829,  found  favor  also  in 
Canada  and  is  still  an  integral  part  of  the  Canadian  banking 
system.  Branch  banking,  which  was  most  successfully  illus- 
trated in  this  country  by  the  State  Bank  of  Indiana,  and  which 
now  exists  in  some  form  or  other  in  almost  all  countries  ex- 
cept the  United  States,  has  always  prevailed  in  Canada.  The 
importance  of  a  prompt  redemption  of  bank  notes  as  exempli- 
fied in  the  old  Suffolk  banking  system  in  New  England  before 
the  war,  was  fully  realized  in  Canada  and  is  probably  better 
illustrated  in  the  present  Canadian  system  than  in  any  other 
country.  There  bank  notes  and  bank  checks  are  treated  as 
identical  in  nature,  both  being  cleared  with  the  same  regularity 
and  promptness.  The  so-called  free  banking  system,  which 
was  first  adopted  in  the  State  of  New  York  in  1839  and  there- 
after adopted  by  eighteen  other  States  of  the  Union,  was  tried 
in  Canada  in  the  fifties,  but  not  on  a  large  scale.  This  system, 
requiring  that  issues  of  bank  notes  should  be  secured  by  a 
segregated  deposit  of  certain  classes  of  stocks  and  bonds,  has 
never  met  with  approval  among  the  leading  bankers  of  Canada. 

The  Canadian  system  is  a  product  of  evolution.  It  has  taken 
its  present  form  because  of  the  commercial  and  financial  needs 
:->f  the  Canadian  people.  It  was  not  created  by  lawyers  or 
statesmen  to  meet  a  fiscal  need  of  the  Government,  but  has 
grown  up  gradually  under  the  fostering  care  of  experienced 
bankers,  no  changes  having  been  made  until  experience  proved 
them  necessary  or  advisable. 

The  chartered  banks  transact  the  business  which  in  the 
United  States  is  divided  among  national  banks,  trust  com- 


408  THE  CANADIAN  BANKING  SYSTEM 

panics,  private  banks,  and  savings  banks.  They  buy  and  sell 
commercial  paper,  discount  the  notes  of  their  customers,  lend 
money  on  stocks  and  bonds,  make  advances  to  farmers,  and 
sometimes  aid  in  the  financing  of  railroads  and  industrial  en- 
terprises. To  a  Canadian  the  word  "  bank  "  means  one  of 
the  twenty-odd  "  chartered  banks,"  for  the  law  prohibits  the 
use  of  the  word  "  bank  "  by  any  other  institution. 

OTHER  FINANCIAL  INSTITUTIONS 

The  only  other  financial  institutions  in  Canada  which  possess 
much  importance  are  the  mortgage  and  loan  companies. 
These  usually  operate  under  charters  granted  by  the  provincial 
legislatures  and  do  a  business  similar  to  that  of  the  farm  and 
mortgage  companies  which  once  flourished  in  the  United 
States,  making  loans  to  farmers  for  a  term  of  years  and  taking 
farm  mortgage  for  security.  They  also  make  loans  upon  urban 
and  suburban  real  estate  and  thus  aid  in  the  upbuilding  of  the 
cities  and  their  suburbs.  The  business  of  these  institutions 
is  made  possible  by  the  fact  that  the  bank  act  does  not  permit 
the  chartered  banks  to  accept  loans  secured  by  real  estate. 

The  Dominion  Government  maintains  a  double  system  of 
savings  banks.  One  set  is  managed  by  the  post-office  depart- 
ment, every  post-office  receiving  deposits.  The  other  set  is 
managed  by  the  finance  department.  The  post-office  depart- 
ment also  sells  annuities  and  old-age  pensions.  The  money  re- 
ceived through  the  savings  banks  is  regarded  as  a  loan  from  the 
people  and  is  used,  like  money  obtained  by  taxation,  in  the  pay- 
ment of  the  Government's  general  expenses.  The  Government 
is  required  to  carry  a  gold  reserve  of  10  per  cent,  against  the 
savings  deposits,  but  no  assets  are  set  aside  for  their  security. 
The  chartered  banks  pay  the  same  rate  of  interest  and  get 
most  of  the  business,  for  they  offer  facilities  with  which  the 
Government  does  not  attempt  to  compete.  Most  of  the  Gov- 
ernment's deposits  come  from  the  poorest  and  most  ignorant 
classes,  people  who  in  all  countries  are  suspicious  of  banks. 
Some  of  the  Canadian  cities  maintain  municipal  savings  banks, 
but  they  are  of  relatively  small  importance. 

Trust  companies  in  Canada  are  not  financial  institutions. 


ESSENTIALS  OF  THE  SYSTEM  409 

They  are  trust  companies  in  fact  as  well  as  in  name,  their 
business  being  to  act  as  trustee  and  administrator.  A  few  of 
them  accept  deposits,  although  it  is  not  certain  that  they  have 
a  right  to  do  so.  The  bulk  of  the  money  they  handle  comes  to 
them  through  the  administration  of  estates  and  trust  funds. 

Private  banking  firms  are  almost  unknown  in  Canada,  there 
being  only  two  or  three  in  the  entire  Dominion,  and  these  do  a 
mortgage  and  loan  business  rather  than  a  strictly  commercial 
banking  business. 

Hence,  if  any  one  seeks  to  understand  the  financial  or  bank- 
ing situation  in  Canada,  he  must  devote  his  attention  in  the 
main  to  the  chartered  banks.  These  through  their  branches 
furnish  the  loanable  capital  necessary  for  the  support  of  the 
Dominion's  trade  and  industry  and  for  much  of  its  agricultural 
enterprise.  To  them  the  Government  turns  when  funds  are 
needed  for  internal  improvements  or  when  the  exchequer  faces 
a  deficit.  The  promoters  of  street  railways,  steam  railways, 
steam  railroads,  and  other  permanent  improvements  take  coun- 
sel with  the  managers  of  these  chartered  banks  before  they  is- 
sue their  securities.  The  banks  as  a  rule  do  not  invest  their 
funds  in -the  stocks  or  bonds  of  new  enterprises,  yet  their  man- 
agers are  the  men  most  familiar  with  the  world's  money  mar- 
kets and  their  approval,  therefore,  of  any  financial  undertaking 
is  highly  esteemed. 

THE  ESSENTIALS  OF  THE  SYSTEM 

A  chartered  bank  in  Canada  is  a  bank  of  branches,  not  a 
bank  with  branches.  The  parent  bank,  technically  known  as 
the  "  head  office,"  neither  takes  deposits  nor  lends  money.  All 
the  banking  business  is  done  by  the  branches,  each  enjoying 
considerable  independence,  but  all  subject  to  the  supervision 
and  control  of  the  head  office.  The  law  places  no  restrictions 
upon  the  number  or  location  of  branches.  Canadian  banks, 
therefore,  have  branches  in  foreign  countries  as  well  as  in 
Canada. 

PROCESS   OF    INCORPORATION 

The  provisions  of  the  bank  act  with  respect  to  the  organiza- 
tion of  new  banks  are  intended  to  guard  against  the  entry  of 


410  THE  CANADIAN  BANKING  SYSTEM 

unfit  or  inexperienced  persons  into  the  banking  business.  The 
minimum  required  capital  of  a  bank  is  $500,000,  of  which  all 
must  be  subscribed  and  one-half  paid  in  before  a  new  bank  can 
open.  At  least  five  men  of  integrity  and  good  financial  stand- 
ing must  agree  to  act  as  provisional  directors  and  secure  a 
favorable  report  on  their  project  from  the  parliamentary 
committee  on  banking  and  commerce.  These  men  must  agree 
to  subscribe  for  fairly  large  blocks  of  stock,  otherwise  the  com- 
mittee will  be  inclined  to  reject  their  application.  They  must 
convince  the  committee  that  their  project  is  a  well  considered 
one,  that  there  is  need  for  the  new  bank.  If  they  satisfy  the 
parliamentary  committee  it  will  be  granted.  The  bank,  how- 
ever, cannot  yet  begin  business.  Provisional  directors  now 
have  merely  the  right  to  advertise  and  cause  stock  books  to  be 
opened.  If  inside  of  one  year  capital  stock  to  the  amount  of 
$500,000  has  been  subscribed  and  $250,000  thereof  paid  in, 
the  provisional  directors  may  call  a  meeting  of  the  sharehold- 
ers, at  which  a  board  of  regular  directors  shall  be  chosen. 
Before  this  meeting  is  held  at  least  $250,000  in  cash  must  be 
paid  over  to  the  Minister  of  Finance.  The  regular  directors 
must  then  apply  to  a  body  known  as  the  treasury  board  for  a 
certificate  permitting  the  bank  to  issue  notes  and  begin  busi- 
ness and  the  treasury  board  may  refuse  this  certificate  unless 
it  is  entirely  satisfied  that  all  the  requirements  of  the  law  have 
been  met.  Delay  on  the  part  of  the  treasury  board  might 
prove  fatal  to  the  new  enterprise,  for  if  a  new  bank  does  not 
obtain  a  certificate  within  one  year  from  the  date  of  its  incor- 
poration, all  the  rights,  powers,  and  privileges  conferred  by 
the  act  of  incorporation  cease.  These  requirements  make  it 
impossible  to  organize  a  new  bank  in  Canada  with  any  degree 
of  secrecy. 

NOTE   ISSUES 

Having  obtained  its  charter,  a  new  bank  must  open  its  head 
office  in  the  place  designated,  and  may  then  proceed  to  establish 
branches  or  agencies,  upon  the  number  and  location  of  which 
the  law  places  no  restriction.  Under  its  charter  it  has  au- 
thority to  issue  circulating  notes  up  to  the  amount  of  its 
unimpaired  paid-up  capital  in  denominations  of  $5  and  multi- 


NOTE  ISSUES  411 

pies  thereof.  An  amendment  of  the  bank  act  passed  July  20, 
1908,  gives  the  bank  the  right  to  issue  what  may  be  called  an 
emergency  circulation  during  the  crop-moving  season  (October 
i  to  January  31).  During  this  period  the  legal  maximum  of 
the  circulation  of  a  bank  is  its  paid-up  capital  plus  15  per  cent, 
of  its  combined  paid-up  capital  and  surplus  or  rest  fund.  This 
emergency  circulation,  which  consists  of  notes  in  form  and 
in  other  respects  exactly  like  the  regular  issues,  is  subject  to  a 
tax  at  a  rate  not  to  exceed  5  per  cent,  per  annum,  the  rate  being 
fixed  by  the  governor  in  council.  If  a  bank's  circulation  does 
not  exceed  its  paid-up  capital,  it  pays  no  tax. 

SECURITY    OF    NOTES 

The  law  is  silent  on  several  subjects  that  seem  of  great  im- 
portance to  most  bankers  in  the  United  States.  For  instance, 
it  does  not  require  that  the  banks  shall  deposit  with  a  govern- 
ment official,  or  in  any  way  set  aside  any  kind  of  security  for 
the  protection  of  the  note  holder.  It  does  not  even  require 
that  the  banks  shall  carry  a  cash  reserve  against  either  notes 
or  deposits,  nor  does  the  law  make  the  notes  a  legal  tender  for 
any  payment.  A  bank  need  not  accept  the  notes  of  other 
banks.  The  Government  does  not  guarantee  the  redemption 
of  the  notes.  Neither  does  it  bind  itself  to  receive  them  in 
payment  of  dues  to  itself. 

Nevertheless  the  notes  of  the  Canadian  banks  are  everywhere 
acceptable  at  par,  the  people  apparently  not  being  at  all  con- 
cerned about  their  "  goodness."  And  their  confidence  in  the 
note  has  been  well  justified,  for  nobody  since  1890  has  lost  a 
dollar  through  the  failure  of  a  bank  to  redeem  its  notes.  Fol- 
lowing are  the  legal  requirements,  which  -for  twenty  years 
have  proved  adequate  protection  for  the  note  holder : 

1.  Every  bank  must  redeem  its  notes  at  its  head  office  and 
in  such  commercial  centres  as  are  designated  by  the  treasury 
board.     The  redemption  cities  are  the  same  for  all  the  banks. 
They  are  Toronto,  Montreal,  Halifax,  Winnipeg,  Victoria,  St. 
John,  and  Charlottetown. 

2.  Each  bank  must  keep  on  deposit  with  the  Minister  of 
Finance  a  sum  of  lawful  money  (gold  or  Dominion  notes) 
equal  to  5  per  cent,  of  its  average  circulation ;  the  total  so  de- 


412  THE  CANADIAN  BANKING  SYSTEM 

posited  is  called  the  "  circulation  redemption  fund."  It  is  a 
guaranty  or  insurance  fund  for  use,  if  need  be,  in  the  redemp- 
tion of  the  notes  of  failed  banks. 

3.  Bank  notes  possess  first  lien  upon  the  assets  of  a  bank. 

4.  Bank  stockholders  are  liable  to  an  assessment  equal  to  the 
par  value  of  their  stock. 

5.  A  bank  must  make  to  the  Minister  of  Finance  on  or  be- 
fore the  fifteenth  of  each  month  a  detailed  statement  of  its 
assets  and  liabilities  on  the  last  business  day  of  the  preceding 
month.     This  monthly  return,  the  form  for  which  is  set  forth 
in  the  act,  must  be  signed  by  three  general  officers. 

6.  The    Canadian    Bankers'    Association,    an    incorporated 
body  of  which  each  bank  is  a  member,  is  given  supervision  by 
the  bank  act  of  the  issue  and  cancellation  of  notes  and  of  the 
affairs  of  a  failed  bank. 

7.  The  notes  of  a  failed  bank  draw  interest  at  5  per  cent, 
from  the  date  fixed  for  their  redemption  by  the  Minister  of 
Finance,  who  may  redeem  them  out  of  the  assets  of  the  bank 
or  out  of  the  "  circulation  redemption  fund." 

IMPORTANCE    OF   REDEMPTION 

Each  of  these  provisions  of  the  law  has  its  value  and  sig- 
nificance, but  only  the  first  is  absolutely  essential  to  the  suc- 
cessful operation  of  the  system.  All  the  other  provisions 
might  be  changed  or  abolished  without  impairment  of  the 
efficiency  of  the  banking  system.  But  the  abolishment  of  this 
redemption  system  would  at  once  give  Canada  a  new  banking 
system.  The  bank  note  is  almost  the  sole  circulating  medium 
in  Canada,  and  the  people  have  confidence  in  it  because  it  is 
tested  every  day  -at  the  clearing  houses  and  proves  itself  as 
good  as  gold.  This  daily  test  would  probably  not  take  place 
with  the  same  regularity  as  now  if  the  banks  did  not  have 
branches  or  if  they  were  obliged  to  deposit  security  against 
their  issues.  Canadian  banks  are  national,  not  local  institu- 
tions. All  but  a  few  of  them  have  branches  in  every  part  of 
the  Dominion,  and  these  branches,  as  fast  as  they  receive  the 
notes  of  other  banks,  either  send  them  in  to  the  nearest  re- 
demption centre  or  convert  them  into  lawful  money  —  or  its 
equivalent,  a  bill  of  exchange  —  through  branches  of  the  issu- 


NOTE  ISSUES  413 

ing  banks  located  in  the  same  towns.  Each  bank  is  seeking, 
through  its  branches,  to  satisfy  all  the  legitimate  needs  of  the 
people  for  a  circulating  medium.  When  the  note  of  a  bank  is 
in  circulation  it  is  earning  money  for  the  bank,  but  when  it  is 
in  the  vault  or  on  the  counter  of  the  bank  it  is  an  idle  and 
useless  piece  of  paper.  Hence  every  bank  always  pays  out  its 
own  notes  through  its  branches  and  sends  the  notes  of  other 
banks  in  for  redemption,  thus  increasing  its  own  circulation 
and  strengthening  its  ozvn  reserve. 

Furthermore,  if  the  banks  were  not  allowed  complete  free- 
dom of  issue  within  the  prescribed  limit,  but  were  required  to 
deposit  some  form  of  security,  as  is  required  of  the  national 
banks  in  the  United  States,  an  investment  or  speculative  risk 
would  arise  that  would  inevitably  cause  friction.  If  bonds 
were  designated  as  security,  bankers  might  often  be  tempted 
by  high  prices  to  sell  their  bonds  and  forego  the  profit  on  cir- 
culation for  the  sake  of  making  a  larger  profit  by  the  sale  of 
the  security.  Thus  the  volume  of  bank  notes  might  contract 
even  at  a  time  when  the  people  needed  more  currency.  In  such 
case,  of  course,  Canada  would  be  obliged  to  import  gold  in 
order  to  fill  the  gap  in  the  circulating  medium. 

THE   CIRCULATION   REDEMPTION    FUND 

The  5  per  cent,  insurance  fund  for  the  redemption  of  the 
notes  of  failed  banks  is  theoretically  an  important  and  promi- 
nent part  of  the  system,  yet  practically  it  would  seem  to  be  of 
little  consequence,  for  not  once  since  1890  has  it  been  necessary 
to  use  a  dollar  of  the  fund.  Banks  have  failed,  to  be  sure,  but 
the  notes  of  these  banks  have  always  been  redeemed  either  out 
of  the  assets  or  by  recourse  to'  the  double  liability  of  the  share- 
holders. It  is  a  mistake  to  suppose  that  the  people  of  Canada 
have  confidence  in  bank  notes  because  of  the  existence  of  this 
redemption  fund.  The  average  business  man  knows  nothing 
about  the  fund  and  if  his  attention  were  called  to  it  as  being 
a  source  of  security  for  the  bank  notes,  he  would  probably  think 
a  5  per  cent,  reserve  altogether  too  small.  The  real  reason 
why  the  people  have  faith  in  bank  notes  is  because  the  notes 
are  always  honored  by  the  banks  and  never  fail  to  stand  the 
test  of  the  clearing  house.  In  other  words,  they  believe  that 


414  THE  CANADIAN  BANKING  SYSTEM 

bank  notes  are  good  for  about  the  same  reason  that  they  believe 
the  sun  will  rise  in  the  east  every  twenty-four  hours,  and  do  not 
bother  themselves  about  reasons. 

Nevertheless  this  redemption  fund  does  contribute  to  the 
strength  of  the  banking  system.  It  makes  each  bank  to  a  cer- 
tain extent  liable  for  the  mistakes  of  other  banks,  and  as  a 
result  gives  rise  to  a  spirit  of  mutual  watchfulness  and  help- 
fulness. Other  features  of  the  system  contribute  to  the  same 
result,  especially  the  fact  that  a  Canadian  bank  accepts  from  a 
depositor  without  indorsement  the  notes  of  other  banks. 
Since  the  banks  have  branches  in  agricultural  and  mining  com- 
munities, often  distant  from  the  railroad  by  several  days' 
journey,  and  these  branches  are  accepting  the  notes  of  other 
banks  and  giving  credit  for  them  as  if  they  were  gold  itself,  it 
is  evidently  important  that  each  banker  should  have  all  possible 
information  with  regard  to  the  status  and  business  of  his  com- 
petitors. As  a  result  one  finds  among  the  bankers  of  Canada 
a  surprisingly  intimate  knowledge  of  each  other's  affairs. 

TWO   NEGATIVE    QUALITIES 

The  two  negative  qualities  of  the  Canadian  bank  note  —  its 
lack  of  a  legal-tender  quality  and  of  a  government  guaranty  — 
at  first  sight  may  seem  to  readers  in  the  United  States  a  source 
of  weakness.  Yet  Canadian  bankers  would  doubtless  all 
agree  that  nothing  would  be  gained  by  making  bank  notes  legal 
tender  for  any  kind  of  payment  or  by  making  the  Government 
in  any  measure  liable  for  their  ultimate  redemption.  Such 
measures  would  probably  be  rejected  as  likely  to  prove  harmful. 
It  would  be  like  hampering  a  flying  machine  with  unnecessary 
bars  of  steel.  Bank  notes,  like  bank  checks,  are  mere  prom- 
ises to  pay  money  and  are  more  convenient  than  money  because 
they  can  be  created  as  need  for  a  medium  of  exchange  arises. 
When  either  has  done  the  work  that  called  it  into  existence,  it 
should  disappear  from  circulation  and  be  redeemed.  If  it  is 
made  a  legal  tender  like  money  itself,  or  if  its  redemption  is 
guaranteed  by  a  strong  government,  there  is  always  the  danger 
that  ignorant  classes  of  people  will  regard  it  as  money  itself 
and  withdraw  it  from  circulation. 

The  Canadian  Government  has  nothing  to  do  with  the  daily 


NOTE  ISSUES  415 

redemption  of  bank  notes  and  does  not  guarantee  that  they 
shall  be  redeemed.  It  is  custodian  of  the  5  per  cent,  redemp- 
tion fund  and  is  under  obligation  to  redeem  the  notes  of  failed 
banks  out  of  this  fund,  but  if  a  series  of  bank  failures  should 
exhaust  it  the  note  holder  has  no  guaranty  that  government 
funds  will  be  used  for  his  relief. 

The  possession  by  the  note  holder  of  a  first  lien  upon  the 
assets  of  a  bank,  including  the  funds  that  may  be  collected  from 
shareholders  on  account  of  their  double  liability,  gives  rise  to 
such  general  confidence  in  the  ultimate  convertibility  of  a  bank 
note  that  the  notes  of  a  failed  bank,  on  account  of  the  interest 
they  bear,  sometimes  command  a  premium.  As  a  rule,  the 
notes  of  such  a  bank  are  collected  by  the  other  banks  and  held 
until  the  date  of  redemption  has  been  named  by  the  Minister 
of  Finance. 

CANADIAN  BANKERS'  ASSOCIATION 

The  Canadian  Bankers'  Association  is  an  incorporated  body 
with  powers  and  duties  prescribed  in  an  amendment  to  the 
Bank  Act  passed  in  1900.  Each  chartered  bank  is  represented 
in  the  membership  and  has  one  vote.  The  association  is  re- 
quired by  law  to  supervise  the  issue  of  bank  notes  and  to  report 
to  the  Government  all  over-issues,  to  look  after  the  destruction 
of  worn  and  mutilated  notes,  and  to  take  charge  of  suspended 
banks.  Its  headquarters  are  in  Ottawa.  The  expenses  of  the 
association  are  apportioned  among  the  banks  and  do  not  ap- 
parently constitute  a  very  heavy  burden,  for  the  secretary  has 
an  exceedingly  small  staff.  All  expenses  incurred  by  the  asso- 
ciation on  account  of  a  suspended  bank  are,  of  course,  a  charge 
against  the  assets  of  the  bank. 

When  the  notes  of  a  bank  are  so  worn  or  multilated  that  it 
wishes  to  replace  them  with  new  notes,  notice  is  sent  to  the 
secretary  of  the  association,  a  date  is  fixed,  and  in  the  presence 
of  the  secretary  the  old  notes  are  duly  counted  and  taken  to  a 
furnace,  where  they  are  consumed  in  the  presence  of  the  secre- 
tary and  other  witnesses,  After  this  solemn  operation  has 
been  performed  and  the  signatures  of  all  parties  observing  it 
have  been  duly  attested,  new  notes  are  issued  by  the  association 
to  replace  those  that  have  been  destroyed. 


41 6  THE  CANADIAN  BANKING  SYSTEM 

The  clearing  houses  in  the  Dominion  are  subject  to  regula- 
tion by  the  association.  It  also  has  the  power  to  establish  sub- 
sections and  to  do  educational  work  by  providing  for  lectures, 
competitive  papers,  examinations,  etc.  The  Journal  of  the 
Canadian  Bankers'  Association,  a  quarterly  publication  of  ex- 
cellent quality,  is  edited  by  the  secretary  and  is  at  present  the 
only  educational  force  at  work  among  bank  employees. 

ELASTICITY   OF   THE   CIRCULATION 

While  the  amount  of  notes  that  the  chartered  banks  may 
issue  is  limited  by  the  Bank  Act  to  the  amount  of  their  paid-up 
capital,  experience  has  proved  that  this  legal  limitation  is  only 
nominal  and  that  the  real  and  effective  limit  is  imposed  un- 
consciously and  automatically  by  their  customers  and  them- 
selves. Each  constantly  seeks  to  increase  its  issue  of  notes  to 
the  legal  limit,  yet  the  combined  efforts  of  all  are  never  able  to 
force  into  circulation  more  notes  than  the  people  need. 

The  reason  why  an  excessive  issue  of  bank  notes  in  Canada 
is  impossible  is  found  in  the  two  following  facts : 

1.  Every  bank  must  redeem  its  notes  on  demand  in  seven 
commercial  centres  in  different  parts  of  the  Dominion. 

2.  The  monetary  circulation  of  Canada,  exclusive  of  $i  and 
$2  bills,  and  "  change  "  consists  entirely  of  bank  notes. 

The  redemption  system  is  an  automatic  and  effectual  check 
against  inflation.  It  is  easier  to  get  notes  redeemed  in  Canada 
than  it  is  to  secure  payment  of  checks  in  the  United  States, 
for  the  notes  are  redeemable  at  different  points  throughout  the 
Dominion  and  no  exchange  is  ever  charged.  If  a  country 
merchant  accumulates  more  currency  than  he  desires  to  keep 
on  hand,  he  deposits  it,  together  with  his  checks  and  drafts, 
in  the -local  branch  of  his  bank.  This  branch  immediately 
sorts  out  the  notes  of  other  banks  and  treats  them  as  it  does 
checks  and  drafts  upon  other  banks,  either  sending  them  to 
the  nearest  redemption  agency  or  using  them  as  an  offset  in 
the  local  clearing  house  if  the  issuing  banks  have  branches  in 
the  locality.  The  branches  of  a  bank  are  not  obliged  to  redeem 
the  notes  of  the  parent  bank,  but  must  accept  them  at  par  in 
the  payment  of  all  dues.  Thus  each  bank  is  doing  its  utmost 
to  bring  about  the  redemption  of  the  notes  of  other  banks.  At 


NOTE  ISSUES  417 

the  same  time  it  is  paying  out  its  own  notes  to  all  customers 
who  ask  for  cash,  seeking  to  bring  its  circulation  up  to  the 
limit.  As  a  result  of  these  operations,  two  powerful  forces  are 
constantly  at  work,  one  putting  notes  into  circulation,  the  other 
retiring  them,  and  the  people  of  Canada  always  have  on  hand 
just  the  amount  of  currency  they  need  and  no  more.  It  is  the 
people,  not  the  banks,  who  determine  how  much  the  circulation 
of  the  banks  shall  be. 

BANK    NOTES   HAVE   NO    COMPETITION 

The  fact  that  the  bank  note  has  exclusive  possession  of  the 
monetary  field  in  Canada  is  most  important.  His  ignorance 
of  this  fact  is  one  reason  why  the  average  banker  or  business 
man  in  the  United  States  has  been  unable  to  get  a  practical 
understanding  of  the  Canadian  system.  Its  significance  is 
easily  seen.  If  Canada,  like  the  United  States,  had  in  circula- 
tion a  lot  of  government  notes  in  denominations  of  $5,  $10, 
$20,  the  Canadian  banks  would  be  able  to  increase  their  issues 
of  bank  notes  almost  without  limit,  for  their  new  notes  would 
simply  take  the  place  of  the  government  notes,  the  latter  going 
into  bank  reserves.  The  people  of  Canada  in  making  deposits 
would  not  discriminate  against  bank  notes,  but  would  deposit 
the  government  paper  quite  as  freely  as  the  bank  paper.  As  a 
result,  the  amount  of  the  government  paper  in  circulation 
would  gradually  decrease  and  the  amount  of  bank  notes  would 
increase.  The  volume  of  Dominion  notes  in  the  vaults  of  the 
banks  would  expand,  and  as  these  notes  are  redeemable  in  gold 
the  banks  would  feel  justified  in  larger  extension  of  their  credit, 
so  that  an  increase  in  deposits  and  current  loans  would  ensue. 
Under  such  circumstances  such  freedom  of  issue  as  is  enjoyed 
by  the  Canadian  banks  would  doubtless  result  in  inflation. 

But  such  conditions  do  not  exist  in  Canada.  All  the  paper 
currency  in  the  hands  of  the  people,  excepting  $i  and  $2  bills, 
is  in  the  form  of  bank  notes.  There  is  no  chance  to  substitute 
bank  notes  for  government  notes.  Hence,  if  at  any  time  busi- 
ness relaxes  and  the  need  for  money  among  the  people  grows 
less,  an  increasing  tide  of  bank  notes  flows  into  the  banks. 
The  people  who  bring  these  notes  do  not  ask  for  money  in 
exchange,  for  to  them  the  notes  are  money.  They  take  bank 


418  THE  CANADIAN  BANKING  SYSTEM 

notes  to  the  banks  just  as  people  in  the  United  States  take 
greenbacks  and  silver  certificates  —  to  be  exchanged  for  a 
deposit  credit  or  account. 

NO    LIMIT   OF   ISSUE   REALLY    NECESSARY 

Theoretically  there  is  no  reason  why  any  limit  should  be 
fixed  upon  the  amount  of  notes  which  a  bank  may  issue.  Even 
though  a  bank  has  a  monopoly  of  issue  in  a  country  —  like  the 
Bank  of  France  —  it  nevertheless  is  unable  to  expand  its  cir- 
culation beyond  the  people's  needs.  Such  a  bank,  unless  it 
should  adopt  a  reckless  policy  of  lending  which  would  bring 
ruin  quickly  upon  itself,  can  exercise  very  little  influence  upon 
the  amount  of  currency  in  circulation.  In  a  country  like  Can- 
ada, where  several  banks  are  issuing  currency,  no  single  institu- 
tion can  enlarge  its  issue  of  notes  beyond  the  needs  of  its  own 
customers.  If  it  should  endeavor  to  do  this  by  lending  freely 
to  customers  who  promised  to  use  its  notes  in  different  parts 
of  the  country,  the  effort  would  be  futile.  The  notes  would 
quickly  find  their  way  into  the  branches  of  other  banks  and  be 
sent  in  for  redemption. 

Like  most  other  countries,  however,  Canada  has  placed  a 
limit  on  the  note-issuing  privilege,  fixing  it  at  the  amount  of  a 
bank's  paid-up  capital.  While  there  is  no  scientific  necessity 
that  such  a  limit  be  fixed  in  order  to  prevent  the  over-issue  of 
notes,  nevertheless  there  are  other  considerations  which  justify 
it.  It  is  an  indirect  method  of  compelling  banks  to  increase 
their  capitalization  pan  passu  with  the  growth  of  their  busi- 
ness. Inasmuch  as  the  capital  of  a  bank  is  the  stockholder's 
contribution  toward  its  assets,  it  is  exceedingly  desirable  that 
this  contribution  be  made  as  large  as  possible,  for,  other  things 
being  equal,  the  strength  of  a  bank  varies  with  the  amount  of 
its  capital.  It  is  not  unreasonable,  therefore,  to  require  that 
banks  in  return  for  the  useful  note-issuing  privilege  should  be 
required  to  keep  their  capital  resources  large. 

When  a  Canadian  bank  has  reached  the  limit  of  its  note  issue 
—  which  has  rarely  happened  —  it  begins  at  once  to  treat  the 
notes  of  other  banks  very  much  as  if  they  were  its  own.  In- 
stead of  going  to  the  expense  of  sending  them  in  for  redemp- 
tion, it  uses  them  as  counter  money,  paying  them  out  to  deposit- 


DEPOSITS  419 

ors  in  response  to  their  calls  for  cash.  If  all  the  banks  in 
Canada  should  issue  notes  up  to  the  limit,  as  some  of  them 
did  during  the  exciting  months  of  1907,  and  if  the  current  rate 
of  interest  did  not  warrant  the  issue  of  the  taxed  notes  pro- 
vided for  by  the  amendment  of  1908,  the  note  circulation 
would  immediately  lose  its  elasticity.  As  further  expansion 
would  be  impossible,  the  banks  would  have  to  meet  any  increas- 
ing demand  for  currency  by  paying  out  gold  and  Dominion 
notes,  thus  depleting  their  reserves.  Such  a  situation  would 
doubtless  lead  to  a  sharp  advance  in  the  discount  rate  and  to 
the  importation  of  gold. 


THE  PRACTICAL  LIMIT  UNDER  THE  LEGAL 

It  should  be  noted  that  the  practical  limit  of  note  issue  is 
about  10  per  cent,  below  the  legal  limit.  The  manager  of  a 
bank  having  a  paid-up  capital  of  $1,000,000  begins  to  get 
nervous  when  his  circulation  equals  $900,000.  His  office  may 
be  in  Montreal  and  his  bank  may  have  branches  in  the  far  East 
and  in  the  far  West  and  in  the  mining  wilderness  of  the  North. 
Some  of  these  branches  he  can  not  reach  by  telegraph  and  some 
are  distant  a  week  by  mail.  He  immediately  sends  warning 
to  all  the  branches  and  cautions  them  against  any  large  out- 
giving of  notes  and  against  entering  into  transactions  which 
will  be  likely  to  lead  to  unusual  demands  for  currency.  On 
account  of  this  situation,  even  in  times  of  greatest  pressure, 
the  total  issue  of  the  banks  is  usually  10  per  cent,  below  the 
authorized  limit. 

DEPOSITS 

The  liabilities  of  Canadian  banks,  like  those  of  commercial 
banks  in  Great  Britain  and  the  United  States,  furnish  a  fairly 
correct  index  to  the  expansion  of  the  country's  credit.  Since 
the  Canadians,  like  other  Anglo-Saxons,  make  free  use  of  the 
check  book  in  the  settlement  of  both  business  and  private  ac- 
counts, any  increase  of  bank  loans  and  discounts  is  usually 
attended  by  a  corresponding  increase  in  deposits.  When  a 
Canadian  business  man  discounts  his  note  at  his  bank  he  al- 
most invariably  leaves  the  proceeds  on  deposit  with  the  bank. 


420  THE  CANADIAN  BANKING  SYSTEM 

As  he  makes  his  payments  by  check  his  own  deposit  account 
declines,  but  the  bank  accounts  of  his  creditors  increase,  so 
that  the  net  result  of  borrowing  in  Canada  is  an  increase  in 
the  total  of  bank  deposits.  Consequently,  in  good  times,  when 
the  banks  are  freely  extending  credit,  the  deposits  grow,  and 
in  periods  of  dullness  and  liquidation  they  decline.  A  growth 
of  deposits,  therefore,  is  commonly  accepted  as  an  indication 
of  business  and  industrial  activity. 

If  a  business  man  in  Canada  has  temporarily  a  large  balance 
in  his  bank  and  realizes  that  he  will  not  need  the  money  for 
several  months,  he  will  either  arrange  for  its  entry  as  a  time 
or  savings  bank  account,  or  for  the  payment  of  interest  on  his 
balance  as  a  current  account.  Of  course,  the  bankers  do  not 
encourage  this  practice,  nor  can  it  be  indulged  in  by  a  de- 
positor who  is  also  a  borrower.  Depositors  of  'the  class  who 
are  paid  a  small  rate  of  interest  —  usually  2  per  cent. —  by 
national  and  state  banks  in  the  United  States,  usually  have 
savings  department  accounts  in  Canada  and  get  3  per  cent. 

SAVINGS   DEPOSITS   ALWAYS   PAID   ON   DEMAND 

•On  account  of  the  fact  that  the  time  or  savings  bank  de- 
posits contain  such  a  large  proportion  of  money  likely  to  be 
needed  in  business  at  any  time,  the  banks  regard  both  classes 
of  deposit  as  being  essentially  the  same  form  of  liability. 
Practically  all  the  deposit  liabilities  of  a  Canadian  bank  are 
payable  on  demand,  although  payment  on  two-thirds  of  them 
at  the  present  time  can  not  legally  be  demanded  until  after 
notice.  Custom  has  made  it  imperative  that  a  Canadian  bank 
shall  pay  any  and  all  of  its  depositors  on  demand.  For  any 
bank  to  refuse  to  let  a  depositor  have  his  money  when  he 
calls  for  it  would  be  regarded  by  the  public  as  an  acknowledg- 
ment of  weakness.  Certainly  no  Canadian  bank  would  take 
the  risk  of  making  the  experiment. 

Canadian  bankers  feel  that  3  per  cent,  is  too  high  a  rate  of 
interest  to  pay  depositors.  This  rate  is  a  matter  of  tacit 
agreement  among  the  banks  and  no  single  bank  can  afford  to 
lower  it,  for  such  action  would  cause  it  a  loss  of  business.  On 
the  other  hand,  if  any  bank,  hoping  to  increase  its  deposits, 
should  offer  to  pay  3^/2  per  cent,  or  4  per  cent.,  its  conduct 


DEPOSITS  421 

would  be  looked  upon  with  grave  disapproval  by  its  competi- 
tors. Some  of  the  new  banks  in  recent  years  have  obtained 
business  in  this  manner  and  have  been  severely  criticised  by 
the  managers  of  the  older  institutions. 

SAVINGS   DEPOSITORS   NOT    PROPERLY   REWARDED 

To  an  outsider  it  would  seem  that  the  savings  bank  depositor 
in  Canada  is  not  generously  treated.  In  the  United  States  he 
gets  4  per  cent,  on  his  savings  even  in  the  large  cities.  In 
Canada,  a  country  where  real  estate  mortgages  yield  from  7  to 
9  per  cent,  and  the  bonds  of  new  corporations  are  selling  at 
prices  giving  the  investor  a  higher  return  than  he  can  get  in  the 
United  States,  it  is  certain  that  a  real  savings  bank  could  well 
afford  to  pay  depositors  4  per  cent.  It  is  doubtless  true  that 
4  per  cent,  is  a  higher  rate  of  interest  than  most  of  the 
savings  depositors  in  the  chartered  banks  have  a  right  to  ex- 
pect. A  large  part  of  these  deposits  are  not  savings  deposits 
at  all.  Nevertheless  it  is  doubtful  if  the  banks  would  be  justi- 
fied in  a  reduction  of  the  rate. 

The  right  solution  of  the  problem  seems  to  lie  in  another 
direction,  namely,  in  the  making  of  a  sharper  distinction  be- 
tween demand  and  savings  deposits.  The  funds  received 
from  both  classes  of  depositors  should  not  be  treated  alike. 
The  money  of  savings  bank  depositors  should  be  invested  in 
bonds  and  mortgages  and  then  could  be  made  to  yield  a  net 
return  of  over  5  per  cent.  If  the  depositors  were  not  allowed 
to  check  upon  their  accounts  they  would  be  a  source  of  such 
little  expense  to  a  bank  that  it  could  easily  afford  to  pay  them 
interest  at  the  rate  of  4  per  cent.  At  the  present  time  the 
banks  are  paying  3  per  cent,  interest  on  money  which  they  are 
lending  to  commercial  borrowers  and  for  the  care  of  which 
they  are  maintaining  an  expensive  force  of  clerks.  Deposi- 
tors who  have  checking  accounts  might  be  allowed  2  per  cent, 
on  large  balances,  but  out-and-out  savings  depositors,  people 
who  make  no  use  of  the  check  book,  are  certainly  entitled  to 
a  4-per-cent.  rate  in  a  country  where  investment  capital  is  as 
fruitful  as  it  is  in  Canada. 

Strictly  speaking,  the  savings  departments  of  the  chartered 
banks  are  not  savings  banks,  for  they  do  not  pretend  to  devote 


422  THE  CANADIAN  BANKING  SYSTEM 

their  time  funds  to  long-time  investments.  The  amount  of 
securities  held  by  the  banks  is  never  equal  to  the  amount  of 
time  deposits. 

A  thorough  reorganization  of  the  savings  departments  of 
the  chartered  banks,  to  equip  them  for  the  real  business  of  a 
savings  bank,  would  not  be  possible  without  an  amendment  to 
the  Bank  Act,  which  now  prohibits  them  from  loaning  money 
upon  real  estate  or  upon  the  security  of  real-estate  mortgages. 
It  is  generally  believed  that  this  prohibition  is  commonly 
evaded  by  the  banks  through  the  acceptance  of  such  mort- 
gages as  "  additional  security  "  after  loans  have  been  made.  A 
savings  bank,  of  course,  must  have  the  legal  right  to  accept 
such  security. 

No  BANKERS'  BANK 

The  indebtedness  of  banks  to  banks  is  not  large  in  Canada. 
The  branch  system  makes  it  unnecessary  for  banks  to  carry 
balances  in  other  institutions  located  in  the  financial  centres. 
Nearly  every  bank  has  a  branch  in  either  Montreal  or  Toronto 
and  in  these  branches  carries  the  major  proportion  of  its  cash 
reserve,  so  that  branches  in  the  far  West  or  in  the  maritime 
Provinces  are  always  able  to  sell  exchange  on  Montreal  or 
Toronto.  Canada  has  no  bankers'  bank.  The  Bank  of  Mon- 
treal, which  is  the  largest  bank  in  the  Dominion,  its  assets 
being  equal  to  about  25  per  cent,  of  the  total,  is  often  spoken 
of  as  the  government  bank  because  it  is  the  largest  government 
depositary,  yet  it  holds  a  very  small  amount  of  funds  belong- 
ing to  other  banks. 

AMOUNT  OF  THE  RESERVE  FIXED  BY  EACH  BANK 

It  must  not  be  supposed  that  the  Canadian  banks  do  not 
carry  adequate  reserves.  On  the  contrary,  every  bank  man- 
ager gives  to  this  subject  daily  and  most  conscientious  thought. 
To  the  Canadian  banker  the  word  "  reserve  "  means  a  fund 
immediately  available  for  the  liquidation  of  liabilities.  How 
much  this  fund  ought  to  be  depends  altogether  upon  the 
amount  and  character  of  the  liabilities  to  be  protected. 

A  Canadian  bank  manager,  having  before  him  the  amount  of 


COMPETITION  423 

time  deposits  and  demand  deposits,  respectively,  knowing  the 
probable  future  needs  of  the  various  depositors,  being  in  con- 
stant touch  with  branch  managers  both  by  wire  and  by  letter, 
and  having  back  of  him  information  born  of  many  years'  ex- 
perience, easily  determines  how  much  his  bank's  reserve  ought 
to  be  in  order  to  assure  its  safety.  The  law  neither  helps  nor 
hinders  him;  it  simply  requires  that  the  bank  shall  satisfy  the 
demands  of  depositors  in  accordance  with  the  terms  of  the 
contract  and  that  it  shall  redeem  its  notes  on  demand.  The 
public  by  force  of  custom  expects  a  bank  to  do  a  little  more 
than  the  law  requires,  for  its  credit  is  bound  to  suffer  if  it 
take  advantage  of  its  legal  privilege  to  delay  payment  upon 
time  deposits.  The  manager  is  a  hired  man,  sworn  to  do  his 
utmost  to  protect  the  credit  of  the  bank,  trained  for  many  years 
in  its  service,  familiar  with  its  history  and  its  policy,  anxious 
to  guard  his  own  reputation  and  character  against  criticism. 
Under  these  circumstances  it  would  be  remarkable  if  he  did  not 
fix  the  amount  of  his  bank's  reserve  nearer  the  ideal  figure  — 
if  an  ideal  banking  reserve  is  possible  —  than  could  possibly  be 
done  by  a  body  of  law-makers  or  of  any  other  men  outside 
the  bank. 

COMPETITION  Is  NOT  LACKING 

In  many  respects  banking  competition  is  quite  as  active  in 
Canada  as  it  is  in  the  United  States.  Apparently  there  are 
only  two  things  which  the  banks  do  not  like  to  do  in  order  to 
attract  business  —  lower  the  discount  rate,  or  advance  the 
rate  paid  on  depositors'  balances.  There  is  no  express  agree- 
ment among  the  bankers  on  these  points,  but  every  banker 
knows  that  he  would  become  persona  non  grata  among  his 
brethren  if  he  should  discount  certain  kinds  of  paper  at  less 
than  6  per  cent.,  or  pay  his  depositors  on  their  monthly  mini- 
mum balances  more  than  3  per  cent,  per  annum.  In  Montreal 
and  Toronto  large  borrowers  can  get  money  at  5  per  cent., 
but  the  average  merchant  and  manufacturer  must  pay  6.  In 
Winnipeg  borrowers  can  do  almost  as  well,  but  farther  west 
the  usual  rate  is  7  per  cent.,  and  in  some  of  the  remoter  dis- 
tricts merchants  and  farmers  alike  pay  8  per  cent.  Bankers 
do  not  believe  in  lowering  the  discount  or  interest  rate  unless 


424  THE  CANADIAN  BANKING  SYSTEM 

they  are  compelled  to  do  so  in  order  to  find  a  market  for  their 
funds. 

Some  of  the  older  institutions  would  like  to  prevent  com- 
petition from  absorbing  the  minor  profits  which  come  from 
collections  and  transactions  in  exchange,  but  they  are  not  en- 
tirely successful.  The  nominal  or  schedule  charges  for  col- 
lections and  exchange  are  frequently  cut  for  the  benefit  of 
business  men  whose  favor  it  is  desired  to  propitiate. 

In  their  efforts  to  get  new  business,  to  be  the  first  to  open  a 
branch  in  a  promising  new  community,  or  to  keep  their  regular 
customers  from  being  dissatisfied,  there  seems  to  be  the  keenest 
kind  of  competition.  Few  villages  of  500  people  can  complain 
that  their  banking  facilities  are  less  than  they  deserve,  and 
many  of  them,  with  barely  enough  business  to  pay  the  expenses 
of  one  branch,  are  supplied  with  two.  The  recent  rapid  in- 
crease in  the  number  of  branches  has  been  caused  by  the  great 
expansion  of  the  West  and  by  the  competition  among  the 
more  progressive  and  energetic  general  managers,  each  desir- 
ing that  his  bank  shall  be  the  first  in  a  promising  field,  even 
though  his  enterprise  lead  him  to  establish  branches  which  at 
first  do  not  pay  expenses.  In  a  new  mining  camp  the  first 
bank,  like  the  first  saloon  or  the  first  boarding  house,  usually 
begins  business  in  a  tent.  Some  of  the  more  conservative 
bank  managers  in  Canada  think  that  new  branches  are  being 
started  in  excess  of  the  country's  needs,  but  others  are  willing 
to  take  chances  on  the  country's  future  and  to  charge  con- 
siderable sums  to  the  debit  side  of  the  profit  and  loss  account 
in  order  to  keep  their  institutions  at  the  front  in  the  great 
and  developing  West. 

BANKING  IN  DIFFERENT  PROVINCES 

It  is  generally  known  that  the  Eastern  branches  get  heavy 
deposits  and  are  creditors  of  the  head  office,  and  that  the  funds 
they  collect  are  forwarded  to  the  Western  branches,  whose 
loans  greatly  exceed  deposits.  Bankers  will  admit  that  this 
transference  of  funds  takes  place,  but  there  is  considerable 
grumbling  about  it  in  the  old  communities  of  the  East,  and  the 
bankers  fear  that  a  monthly  or  even  annual  publication  of 


BANKING  IN  DIFFERENT  PROVINCES  425 

the  facts  would  keep  them  perpetually  in  hot  water.  A  glance 
at  clearing-house  statistics  leaves  no  doubt  as  to  the  banking 
importance  of  the  Western  Provinces  or  as  to  the  relative 
financial  quietude  of  the  East.  Between  1900  and  1909  the 
total  of  Canada's  bank  clearings  increased  227  per  cent.,  but 
Halifax  gained  only  23  per  cent.,  St.  John  only  90  per  cent., 
and  Quebec  only  68  per  cent.  On  the  other  hand,  Toronto's 
clearings  increased  179  per  cent.,  Winnipeg's  600  per  cent,  and 
Vancouver's  524  per  cent. 


EASTERN    PROVINCES    HAVE   SUFFERED 

This  transference  of  funds  from  sluggish  to  active  com- 
munities is  the  inevitable  result  of  a  system  of  branch  banking 
and  is  the  cause  of  the  tendency  of  the  rate  of  interest  toward 
uniformity  in  all  parts  of  Canada.  Whatever  may  be  said 
against  a  system  of  branch  banks,  there  can  be  no  question  that 
it  does  bring  about  a  more  even  distribution  of  capital  in  a 
country  than  is  possible  under  a  system  of  independent  local 
banks.  Canadian  bank  managers  are  anxious  to  put  out  their 
money  where  it  is  most  wanted,  for  there  they  get  the  best 
possible  rate  of  interest  and  obtain  paper  of  the  best  quality. 
No  matter  where  a  manager's  headquarters  may  be,  he  is  most 
deeply  concerned  in  three  questions :  ( i )  WThere  is  idle  money 
accumulating?  (2)  How  can  he  best  draw  it  into  his  bank? 
(3)  In  what  parts  of  the  Dominion  is  money  most  needed?  In 
localities  of  both  kinds  he  establishes  branches ;  in  the  one  the 
branches  accumulate  deposits  often  much  in  excess  of  their 
loans,  in  the  others  the  loans  exceed  the  deposits.  Thus  it 
happens  that  the  savings  of  the  Eastern  Provinces,  where  the 
growth  of  industry  and  trade  is  slow  and  the  demand  for  new 
capital  is  not  increasing,  are  sent  westward  and  loaned  out 
to  merchants  and  manufacturers  and  farmers  of  the  new  terri- 
tories. The  people  of  the  East  supply  the  capital  for  the 
development  of  the  West,  though  many  of  them  perhaps  are 
entirely  jgr.orant  of  the  useful  purpose  their  savings  are  made 
to  perfw-.  .  In  the  western  cities  of  Canada  one  hears  no 
talk  among  business  men  about  the  scarcity  of  capital.  A 
merchant  or  manufacturer  in  Manitoba  gets  the  money  he 


426  THE  CANADIAN  BANKING  SYSTEM 

needs  as  easily  as  does  the  merchant  or  manufacturer  in  To- 
ronto or  Montreal. 

Justifiable  as  the  bank's  policy  is  from  a  national  point  of 
view,  one  can  not  help  believing  that  the  branch  banking  system 
has  really  checked  the  development  of  business  and  industry 
in  the  maritime  Provinces.  If  Canada  during  the  last  thirty 
years  had  depended,  like  the  United  States,  upon  independent 
local  banks,  there  would  have  been  a  plethora  of  capital  in  the 
East,  and  Montreal,  Quebec,  and  Halifax,  like  Boston,  New 
York,  and  Philadelphia,  would  years  ago  have  had  4  and  5 
per  cent,  money,  while  Winnipeg  and  other  Western  cities, 
less  populous  than  now,  would  still  be  paying  i  per  cent,  a 
month.  The  relative  cheapness  of  capital  undoubtedly  helped 
build  up  the  prosperous  industries  of  Massachusetts.  The 
same  cause  operating  in  the  maritime  Provinces  of  Canada 
would  doubtless  have  led  to  the  establishment  there  of  in- 
dustries of  which  the  people  under  existing  conditions  have 
not  ventured  to  dream. 

LARGE  USE  OF  DEPOSIT  CURRENCY 

It  is  sometimes  assumed  that  a  free  and  large  use  of  bank 
notes  tends  to  discourage  the  use  of  the  check  book  and  the 
growth  of  bank  deposits.  On  the  continent  of  Europe,  for 
instance,  where  the  notes  of  central  banks  supply  all  the  cur- 
rency the  people  need,  the  check  book  is  comparatively  little 
used.  This  fact  is  sometimes  explained  by  the  ease  with  which 
people  can  obtain  bank  notes  for  use  in  making  all  payments. 
Experience  in  Canada  makes  one  doubt  the  validity  of  this 
explanation.  The  check  book  is  almost  as  popular  there  as  in 
the  United  States,  and  would  probably  be  used  still  more  than 
it  is  if  the  banks  would  adopt  a  policy  as  liberal  as  that  in 
vogue  in  the  United  States.  The  Canadian  banks  not  only 
charge  exchange  on  checks  and  drafts  payable  in  other  locali- 
ties, but  even  charge  exchange  on  checks  drawn  on  their  own 
branches.  The  charge  is  a  small  one  and  probably  has  no  great 
effect  one  way  or  the  other,  yet  it  certainly  does  not  encourage 
the  increase  of  deposits  or  the  use  of  the  check  book.  When 
a  Canadian  starts  on  a  journey  it  is  in  a  small  way  economical 


DEPOSITS  427 

for  him  to  fill  his  wallet  with  all  the  cash  he  expects  to  need. 
The  notes  of  his  bank  will  be  taken  at  par  everywhere  through- 
out the  country ;  his  checks,  even  though  he  presents  them  at  a 
branch  of  his  bank,  will  be  cashed  only  at  a  discount. 

Notwithstanding  this  discrimination  against  the  check,  the 
deposits  of  Canadian  banks  have  grown  much  more  rapidly 
than  the  note  circulation  and  the  inference  is  that  the  volume 
of  deposit  currency  has  increased  at  the  same  rapid  pace. 
Since  1900  the  volume  of  notes  has  increased  approximately 
60  per  cent.,  while  the  deposits  by  the  public  showed  a  gain  of 
155  per  cent.  These  figures  -prove  that  business  men  in 
Canada  appreciate  the  advantages  of  the  check  as  a  means  of 
payment,  and  that  the  proportion  of  business  transactions 
settled  by  it  is  steadily  increasing. 

BANKS  SILENT  PARTNERS  IN  INDUSTRY 

A  large  part  of  the  so-called  commercial  paper  of  Canadian 
banks  is  secured  practically  by  title  to  goods  in  warehouses, 
factories,  and  wholesale  stores.  Such  security  is  more  saleable 
than  stocks  and  bonds,  and  paper  having  such  security  back  of 
it  is  therefore  better  banking  paper  than  notes  secured  by  stock- 
market  collateral.  So  far  as  would  seem  possible  the  Ca- 
nadian Bank  Act  makes  merchandise  of  all  kinds  a  sort  of 
collateral  security  for  bank  advances.  It  assumes  that  if  a 
bank  advances  capital  for  the  conduct  of  a  business  it  should 
have  a  claim  upon  all  the  assets  of  the  business  and  upon  all 
goods  as  they  come  and  go  in  the  course  of  trade.  No  matter 
how  a  merchant's  stock  may  change  in  character,  it  all  belongs 
to  his  bank  in  case  he  fails  to  take  up  his  paper  or  meet  his 
engagements.  In  the  same  way  a  manufacturer's  stock  of 
goods,  the  raw  material  and  the  finished  products,  no  matter 
how  they  change  from  day  to  day  and  month  to  month,  will 
become  the  property  of  his  bank  if  he  fails  to  pay  his  note. 
The  law  practically  makes  every  bank  a  silent  partner  in  many 
wholesale  and  manufacturing  businesses  and  gives  it  many 
rights  which  no  ordinary  silent  partner  can  acquire.  It  has 
the  effect  naturally  of  making  bankers  keep  a  close  eye  upon 
business  conditions  as  well  as  upon  the  affairs  of  their  indi- 


428  THE  CANADIAN  BANKING  SYSTEM 

vidual  borrowers.  Canadian  bankers  are  interested  in  the 
lumber  market,  in  the  prices  of  metals,  in  changes  in  the  tariff, 
and  in  the  acquisition  of  foreign  markets  for  Canadian  manu- 
factures and  products,  even  as  the  Wall  Street  banker  is  inter- 
ested in  the  prices  of  stocks  and  bonds.  He  is  in  a  sense  the 
owner  of  merchandise  of  all  kinds,  and  both  trade  and  financial 
news  has  equal  significance  to  him. 

A  CUSTOMER'S  LINE  OF  CREDIT 

In  Canada  the  banks  are  managed  by  men  whose  long  ex- 
perience in  the  business  has  taught  them  to  avoid  certain 
banking  practices  that  are  in  vogue  in  other  countries.  Realiz- 
ing how  important  is  the  relation  between  a  bank  and  its 
customer,  they  believe  that  this  relation  should  be  made  as 
intimate  and  helpful  as  possible.  Among  Canadian  bankers, 
therefore,  it  is  part  of  the  law  and  gospel  of  banking  that  a 
bank  is  entitled  to  full  knowledge  of  the  financial  condition  and 
business  operations  and  prospects  of  its  customers.  Hence  a 
bank  insists  that  its  customers  shall  rely  entirely  upon  itself, 
that  they  shall  make  a  full  statement  of  their  affairs  at  least 
once  a  year,  and  that  they  shall  begin  each  year  with  a  clean 
slate. 

As  a  result  of  this  policy  a  business  man  in  Canada  deals 
exclusively  with  one  bank.  Once  a  year  he  arranges  with  his 
bank  for  a  line  of  credit  and  learns  exactly  the  amount  of 
paper  he  will  be  able  to  discount  If  he  happens  to  need  less 
than  he  anticipated,  he  will  not  exhaust  the  credit  allowed  by 
the  bank  and  will  pay  interest,  of  course,  only  upon  such  por- 
tion of  the  bank's  funds  as  he  actually  utilizes.  If,  on  the 
other  hand,  his  business  is  unexpectedly  large,  giving  oppor- 
tunity to  make  bigger  profits  and  creating  the  need  for  more 
capital,  he  will  find  the  bank  ready  to  increase  his  line  of 
credit,  provided  the  manager  is  satisfied  that  business  condi- 
tions and  prospects  warrant  expansion.  Under  '.no  circum- 
stances, however,  must  the  customer  of  a  bank  seek  to  raise 
funds  elsewhere  unless  he  first  gets  the  consent  of  his  bank. 
If  he  sells  his  notes  in  the  open  market,  he  must  do  it  with  the 


A  CUSTOMER'S  LINE  OF  CREDIT  429 

full  knowledge  of  his  bank  or  run  the  risk  of  being  placed 
upon  the  "  black  list." 

As  one  would  naturally  expect,  there  is  very  little  com- 
mercial paper  floating  about  in  the  Canadian  money  market. 
The  bill  broker  is  unknown.  Wholesalers  and  manufacturers, 
unless  shipping  to  foreign  countries,  do  not  draw  upon  their 
customers.  If  credit  is  granted,  it  takes  the  form  of  a  book 
account  or  of  a  promissory  note. 

The  promissory  notes  received  by  a  manufacturer  or 
wholesaler  are  deposited  with  his  bank.  The  book  accounts 
under  ordinary  conditions  remain  entirely  at  the  disposal  of 
the  business,  but  in  extraordinary  cases,  when  the  situation  is 
not  satisfactory,  or  if  an  additional  credit  at  the  bank  is  de- 
sired, an  assignment  of  the  book  accounts  to  the  bank  may  be 
required. 

During  the  harvest  season  heavy  drafts  are  made  upon  the 
resources  of  the  banks  to  provide  for  the  movement  of  the 
grain  crops  of  the  West.  In  its  advance  of  money  for  this 
purpose  the  law  makes  it  possible  for  a  bank  always  to  have 
abundant  security.  Under  section  88  of  the  Bank  Act  the 
buyer  makes  assignment  to  his  bank  of  the  grain  purchased. 
When  the  grain  is  delivered  to  a  railroad,  the  bill  of  lading 
becomes  the  property  of  the  bank.  WThen  it  reaches  Port 
Arthur,  or  some  other  distributing  point,  and  is  stored  in  an 
elevator,  the  bank  receives  a  warehouse  receipt  in  exchange 
for  the  bill  of  lading;  and  when  shipment  is  made  to  New 
York,  to  Montreal,  or  to  Europe,  the  bank  receives  on  sur- 
rendering the  warehouse  receipt  the  shipper's  draft  on  the 
consignee,  the  bill  of  lading,  and  other  documents.  Through- 
out the  entire  transaction,  from  the  purchase  from  the  farmer 
to  the  final  sale  to  the  Eastern  consumer,  the  bank  practically 
has  title  to  all  agricultural  products  which  are  being  moved  by 
means  of  its  funds. 

LOANS  TO  FARMERS 

The  branches  of  Canadian  banks  in  agricultural  districts 
quite  commonly  lend  assistance  to  farmers.  They  do  not 


430 


THE  CANADIAN  BANKING  SYSTEM 


make  a  practice  of  taking  mortgages  on  farm  property,  but 
lend  outright  on  the  farmer's  credit,  depending  for  their  se- 
curity upon  his  character  as  a  man  and  ability  as  a  farmer, 
and  often  as  well  upon  a  neighbor's  indorsement.  Farmers' 
paper  ranks  high  among  the  Canadian  bankers  and  constitutes 
a  considerable  proportion  of  the  assets  of  some  of  the  banks. 
The  banks,  of  course,  do  not  undertake  to  supply  the  farmer 
with  anything  more  than  working  capital.  They  do  not  help 
him  pay  for  his  land  and  buildings,  but  they  do  let  him  have  at 
least  part  of  the  money  he  needs  for  tools,  wages,  seed,  stock, 
etc.  Despite  the  fact  that  these  advances  are  unsecured  by 
mortgage,  the  banks  suffer  very  little  loss  on  farm  paper. 

CALL  LOANS  IN  CANADA  AND  ELSEWHERE 

After  "  current  loans  in  Canada  "  the  next  largest  item 
among  the  assets  is  "  call  and  short  loans  elsewhere  than  in 
Canada."  The  call  loans  outside  of  Canada  consist  mainly 
of  loans  in  the  New  York  market  and  are  as  a  rule  secured 
by  collateral  easily  convertible  into  cash.  These  loans  are  re- 
garded by  Canadian  bankers  as  equivalent  to  cash  and  are 
figured  by  them  as  part  of  their  reserve.  Only  the  larger 
banks  make  a  practice  of  loaning  on  call  in  New  York. 

THE  BANKS  AS  FINANCIAL  INSTITUTIONS 

That  the  chartered  banks  of  Canada  are  financial  as  well  as 
commercial  institutions  is  evidenced  by  their  holdings  of 
stocks  and  bonds.  These  securities  represent  partly  an  invest- 
ment carried  as  a  secondary  reserve  and  partly  a  business  car- 
ried on  for  the  benefit  of  their  customers.  In  Canada  the  de- 
mand for  long-time  investments  is  not  large,  but  whatever 
market  there  is  for  securities  is  mainly  in  the  hands  of  the 
chartered  banks.  An  investor  seeks  the  advice  of  a  bank 
manager  and  often  is  able  to  obtain  from  him  securities  which 
satisfy  his  needs.  The  banks  do  not  publish  a  list  of  their 
holdings,  but  it  is  generally  taken  for  granted  that  they  carry 
only  gilt-edge  securities.  If  a  customer  desires  to  obtain  second 
or  third  rate  securities,  being  eager  for  a  high  rate  of  return, 


REVISION  OF  THE  BANK  ACT  431 

a  bank  can  accommodate  him,  not  by  selling  him  out  of  its  own 
stock,  but  by  negotiating  the  purchase  of  the  desired  securities 
in  New  York  or  London. 

As  the  wealth  in  Canada  increases  and  idle  capital  accumu- 
lates in  excess  of  its  immediate  needs,  this  financial  side  of 
the  business  of  Canadian  banks  will  doubtless  expand.  It  may, 
indeed,  during  the  next  generation  or  two  greatly  expand  and 
become  an  important  feature  of  the  chartered  banks.  They 
are  in  a  position  to  take  care  of  the  business  as  it  develops  and 
will  doubtless  be  able  to  prevent  the  establishment  of  any 
purely  financial  banking  houses  in  Canada. 


THE  REVISION  OF  THE  BANK  ACT, 

The  Canadian  Bank  Act,  as  is  well  known,  is  subject  to  de- 
cennial revision.  The  last  revision  was  due  to  take  place  in 
1910;  but  owing  to  circumstances  which  it  is  not  necessary  here 
to  describe,  it  was  not  until  the  present  year  that  the  work  was 
finally  undertaken.  The  leading  features  of  the  Canadian 
banking  system  are  so  well  known  that  they  may  be  passed 
over,  and  the  nature  and  causes  of  the  recent  changes  in  the 
act  alone  described.  There  were  many  minor  modifications, 
but  the  essential  changes  effected  were:  (i)  provision  for  a 
shareholders'  audit,  (2)  the  creation  of  central  gold  reserves, 
and  (3)  the  providing  of  additional  facilities  for  making  loans 
to  farmers. 

In  the  recent  revision  of  the  act  the  public  was  most  deeply 
concerned  with  the  problem  of  securing  an  adequate  system 
of  bank  inspection.  The  immediate  reason  for  this  was  the 
disastrous  failure  of  the  Farmers'  Bank.  This  institution  had 
gambled  away  its  resources  on  the  Keeley  mine;  and  had,  in 
its  failure,  brought  many  farmers  as  well  as  others  to  the  verge 
of  ruin.  For  several  years  previous,  however,  there  had  been 
an  insistent  demand  for  some  sort  of  external  bank  inspec- 
tion. .  .  . 

The  banks  as  a  whole  have  been  opposed  to  any  change  in 
the  method  of  inspection.  The  reason  they  advance  is  that 

1  W.  W.  Swanson,  The  Revision  of  the  Canadian  Bank  Act,  American 
Economic  Review,  Vol.  3,  December,  1913,  pp.  993-998- 


432  THE  CANADIAN  BANKING  SYSTEM 

the  keynote  of  the  organization  of  Canadian  banks  has  always 
been  the  centralization  of  responsibility;  and  they  do  not  think 
it  wise  to  divide  that  responsibility  with  any  outside  au- 
thority. .  .  . 

As  far  as  the  public  is  concerned  it  has  no  means  of  judging 
of  the  soundness  of  a  bank  except  by  examining  the  monthly 
returns  which  are  required  by  law  from  each  bank.  These  re- 
turns are  fairly  comprehensive,  and  have  been  made  more  so 
by  the  revision  of  the  act  this  year.  The  Minister  of  Finance 
may  call  for  supplementary  information  from  any  bank,  when- 
ever, in  his  judgment,  such  data  are  required  to  afford  a  fuller 
knowledge  of  a  bank's  affairs.  Of  course,  these  returns  can 
be  taken  only  for  what  they  are  worth.  In  the  case  of  several 
failed  banks  the  returns  were  made  with  every  degree  of  falsifi- 
cation, because  no  independent  checking  of  the  "figures  was 
possible. 

Nevertheless,  in  obedience  to  the  strong  demand  for  some 
sort  of  independent  bank  examination,  provision  was  made  in 
the  recent  revision  of  the  act  for  a  shareholders'  audit  of  each 
bank's  affairs.  The  auditors  are  to  be  chosen  by  the  share- 
holders from  a  list  of  forty  names  selected  by  the  whole  body 
of  the  general  managers  of  the  banks.  The  list  must  be  sub- 
mitted to  the  Minister  of  Finance  for  his  approval.  If  one- 
third  of  the  shareholders  of  a  bank  are  dissatisfied  with  the 
auditor  appointed  by  the  majority,  they  may  appeal  to  the 
Minister  for  the  appointment  of  another  auditor. 

The  auditors  must  submit  a  statement  of  their  findings  to 
the  shareholders  at  the  annual  meeting,  or  on  any  other  oc- 
casion the  necessity  may  require.  In  addition  the  Minister 
of  Finance  may  require  a  special  return  to  be  made  to  him,  the 
cost  of  the  service  rendered  being  paid  for  by  the  Government. 

Canadians  would  be  wise  not  to  expect  too  much  from  this 
system  of  external  examination.  After  all,  it  can  do  no  more 
than  verify  a  bank's  statements  and  books.  ...  In  every  large 
undertaking,  the  soundness  of  the  transaction  must  depend,  as 
before,  upon  the  judgment  of  the  general  manager  and  the 
board  of  directors. 

The  establishment  of  central  gold  reserves  is  the  most  im- 
portant feature  added  to  Canada's  banking  system  by  the  legis- 


REVISION  OF  THE  BANK  ACT  433 

lation  of  1913.  .  .  .  Under  the  new  act  each  bank  may  issue 
any  amount  of  notes  that  it  may  desire,  provided  that  it  de- 
posits with  a  board  of  trustees,  at  Montreal,  gold  or  Dominion 
notes  to  the  full  amount  of  the  notes  issued.  These  notes  are 
to  be  identical  in  form  with  the  ordinary  notes  of  the  bank. 
The  gold  or  Dominion  notes  deposited  with  the  trustees  shall 
be  returned  to  the  bank  whenever  the  notes  which  the  bank  has 
outstanding  do  not  amount  to  the  paid-up  capital  of  the  bank 
together  with  the  amount  of  legal-tender  money  deposited  with 
the  trustees.  In  other  words,  the  banks  can  still  issue  their 
notes  up  to  the  full  amount  of  their  paid-up  capital,  and  an 
additional  amount  from  September  i  to  the  end  of  the  follow- 
ing February,  which  may  equal  15  per  cent,  of  a  bank's  com- 
bined capital  and  surplus.  It  is  only  for  notes  issued  in  ex- 
cess of  these  amounts  that  legal-tender  money  must  be  de- 
posited with  the  trustees  at  Montreal.  It  should  be  observed, 
however,  that  the  banks  pay  a  tax  of  4  per  cent,  on  the  extra 
issue  during  the  crop-moving  period,  whereas  there  is  no  tax 
upon  gold-reserve  notes.  And  as  Canadian  banks  are  not  re- 
quired to  keep  a  legal  reserve  against  their  demand  liabilities, 
there  is  no  reason  why  the  idle  gold  in  their  reserves  should 
not  be  sent  to  Montreal  to  form  the  basis  of  new  note  issues, 
especially  when  it  is  considered  that  the  gold  may  be  recalled 
at  once  when  no  longer  needed  to  cover  notes. 

The  ability  to  issue  notes  to  any  amount  required,  on  a 
gold  basis,  will  greatly  strengthen  the  position  of  the  banks. 

The  third  important  new  feature  in  the  revision  of  the  act 
is  the  power  given  to  the  banks  to  make  loans  to  farmers  on 
grain  which  is  stored  on  the  farm  and  still  in  the  farmer's 
possession.  .  .  .  The  permission  granted  them  to  loan  money 
to  farmers  on  stored  grain  in  the  latter's  possession  is  an 
attempt  to  extend  to  the  farmers  aid  similar  to  that  hitherto 
granted  to  manufacturers  and  wholesalers  alone.  It  should 
not  be  thought,  however,  that  the  banks  have  not  always 
granted  loans  liberally  to  farmers.  .  .  . 

The  possibility  of  making  advances  to  the  farmers  on  their 
grain  is  expected  to  be  of  especial  benefit  to  the  West.  .  .  . 
It  is  hoped  that,  under  the  new  legislation,  the  farmer  will  be 
able  to  hold  his  grain  for  higher  prices ;  and  in  the  meantime 


434 


THE  CANADIAN  BANKING  SYSTEM 


secure  accommodation  from  the  banks  to  meet  his  obligations. 
Many  bankers,  however,  refuse  to  see  any  remedy  for  the 
situation  in  the  new  legislation.  They  maintain  that  it  will 
involve  too  much  risk  to  extend  loans  on  grain  over  which  the 
farmer  continues  to  assert  control.  Only  the  operation  of 
time  will  enable  us  to  estimate  the  value  of  this  feature  of 
the  act. 


COMPARATIVE  FIGURES  OF  CONDITION  OF  CANADIAN 
BANKS 1 

ASSETS 

Nov.  30, 1915    June  30, 1914- 
Gold  and  subsidiary  com  — 

In   Canada    $41,831,732  $28,948,841 

Elsewhere 29,527,921  17,160,111 

.  Total $7L359.653  $46,108,952 

Dominion  notes 140,751,331  92,114,482 

Deposit  with   Min.   of  Finance   for  security 

of  note  circulation  6,770,645  6,667,568 

Deposit  in  central  gold  reserves  15,100,000  3,050,000 

Due  from  banks  169,429,330  123,608,936 

Loans  and   discounts    881,101,540  925,681,906 

Bonds,  securities,  etc 121,953,898  102,344,120 

Call  and  short  loans  in  Canada 83,263.787  67,401,484 

Call  and  short  loans  elsewhere  than  in  Canada  135,530,562  137,120,167 

Other  assets  76,993,424  71,209,738 

Total $1,702,194,170  $1,575,307,413 

LIABILITIES 

Capital  authorized $188,866,666  $192,866,666 

Capital    subscribed    114.422,866  115.434,666 

Capital  paid   up   113,987,275  114,811.775 

Reserve    fund    1 12.718,473  1 13.368,898 

Circulation    124.153,685  99,138.029 

Government   deposits    36,001,548  44.453.738 

Demand  deposits    538.764,279  458,067,832 

Time  deposits   714,219,286  663,650,230 

Due  to  banks    30,973,072  32.426.404 

Bills   payable    5,081.059  20,096.365 

Other   liabilities    ...«- 14.007,918  12.656,085 


Total,  not  including  capital  or  reserve  fund  $1,463,200,847   $1,330,488.683 

NOTE. —  Owing  to  the  omission  of  the  cents  in  the  official  reports,  the 
footings  in  the  above  do  not  exactly  agree  with  the  totals  given. 

1  The  Commercial  and  Financial  Chronicle,  Vol.  102,  January  i,  1916, 


CHAPTER  XXII 
THE  ENGLISH  BANKING  SYSTEM 

FOUNDATION  AND  GROWTH  OF  THE  BANK  OF  ENGLAND 

IABOUT  the  year  1691  the  Government  of  William  and 
Mary  experienced  considerable  difficulty  in  raising  the  neces- 
sary funds  to  prosecute  the  war  with  France ;  but  "  the  hour 
brings  the  man."  The  man  on  this  occasion  was  William 
Paterson,  a  merchant  of  Scotland,  who  had  been  educated  for 
the  Church,  but  had  led  a  varied  and  adventurous  life.  The 
scheme  he  presented  for  the  consideration  of  the  Government 
for  the  relief  of  the  situation  was  the  foundation  of  a  public 
joint-stock  bank;  which,  in  return  for  certain  powers  and 
privileges  to  be  conferred,  should  advance  money  to  the  Gov- 
ernment. .  .  . 

.  .  .  the  bill  establishing  the  Bank  of  England  was  suc- 
cessfully carried  through  Parliament,  and  obtained  the  royal 
assent  on  the  25th  April,  1694. 

The  basis  of  the  bill  was  that  £1,200,000  should  be  volun- 
tarily subscribed  by  the  public,  and  that  the  subscribers  should 
be  incorporated  into  a  body,  to  be  known  as  "  The  Governor 
and  Company  of  the  Bank  of  England." 

The  whole  of  the  sum  forming  the  capital  of  the  bank  was 
to  be  lent  to  the  Government,  for  which  the  bank  was  to  re- 
ceive interest  at  the  rate  of  8  per  cent,  per  annum,  together 
with  an  allowance  of  £4,000  per  annum  for  management  and 
expenses;  making  in  all  £100,000  per  annum.  It  was  also 
provided  that  the  sum  of  £300,000  was  to  be  raised  by  public 
subscription,  for  which  the  contributors  were  to  receive  cer- 
tain terminable  annuities. 

By  its  first  charter,  which  was  for  ten  years  only,  the  Bank 
of  England  was  not  allowed  to  borrow  or  owe  more  than  the 

1F.   Straker,   The  Money  Market,  pp.  7-16.    Methuen  and   Company. 
London.    1904. 

435 


436  THE  ENGLISH  BANKING  SYSTEM 

amount  of  its  capital;  which  meant  that  it  could  issue  notes 
to  the  extent  of  its  capital  and  no  more.  If  this  amount  were 
exceeded  the  members  were  liable  for  such  excess,  in  their 
private  capacities,  in  proportion  to  their  holding  of  stock. 

The  capital  of  the  bank  was  subscribed  in  a  few  days,  and 
when  duly  paid  up,  the  agreed  sum  of  £1,200,000  was  handed 
in  to  the  Exchequer.  .  .  . 

The  charter  originally  granted  to  the  bank  was  for  ten  years 
only,  as  we  have  already  seen ;  but  this  charter  has  from  time 
to  time  been  renewed,  and  also  varied  —  sometimes  in  favour 
of  the  bank  and  sometimes  curtailing  its  privileges.  The 
monopoly  of  joint-stock  banking  was  not  granted  to  the  bank 
by  its  first  charter,  but  this  monopoly  was  practically  conferred 
on  it  in  1708.  The  act  passed  in  that  year  provides : 

That  during  the  continuance  of  the  said  corporation  of  the 
Governor  and  Company  of  the  Bank  of  England,  it  shall  not  be 
lawful,  for  any  body  politic  or  corporate  whatsoever,  created  or  to 
be  created  (other  than  the  said  Governor  and  Company  of  the  Bank 
of  England),  or  for  any  other  persons  whatsoever,  united  or  to  be 
united  in  covenants  or  partnership,  exceeding  the  number  of  six 
persons,  in  that  part  of  Great  Britain  called  England,  to  borrow, 
owe,  or  take  up  any  sum  or  sums  of  money  on  their  bills  or  notes, 
payable  at  demand,  or  at  a  less  time  than  six  months  from  the  bor- 
rowing thereof.  .  .  . 

We  pass  on  now  to  the  end  of  the  eighteenth  century,  when 
the  country  was  plunged  into  the  throes  of  war  and  financial 
difficulty.  Up  to  this  time  the  bank,  since  its  foundation,  had 
succeeded  in  meeting  its  notes  when  presented ;  but  in  the  year 
1796  a  steady  drain  on  the  reserve  of  the  bank  commenced, 
owing  to  the  fear  of  invasion.  This  drain  began  to  assume  a 
very  serious  aspect  in  the  early  part  of  1797,  and  it  appeared 
probable  that  the  bank  would  be  subjected  to  the  danger  and 
humiliation  of  a  temporary  stoppage.  The  directors,  fully 
aware  of  this  danger  ahead  of  them,  laid  the  position  before 
the  Government,  and  left  the  solution  of  the  difficulty  in  its 
hands.  After  due  consideration,  an  Order  in  Council  was 
issued  on  the  26th  February,  1797,  requiring  the  bank  not  to 
pay  its  notes  in  gold.  ...  It  was  not  until  1823  that  the 
restriction  was  entirely  withdrawn,  although  as  a  matter  of 


THE  BANK  OF  ENGLAND  437 

fact  the  bank  really  resumed  paying  in  cash  on  demand  on 
May  i,  1821,  deeming  it  then  safe  to  do  so. 

Although  a  period  of  safety  and  prosperity  then  appeared 
to  have  dawned,  the  bank  was  not  quite  clear  of  its  troubles. 
The  very  prosperity  of  the  times  led  imperceptibly  to  another 
period  of  distress  and  danger,  culminating  in  the  panic  of 
1825.  .  .  . 

In  1826  the  Bank  of  England,  by  arrangement  with  the 
Government,  agreed  to  establish  branches  in  various  parts  of 
the  country,  and  gave  up  their  monopoly  of  joint-stock  bank- 
ing, except  within  a  radius  of  sixty-five  miles  of  London. 

The  year  1833,  however,  saw  a  further  restriction  in  the 
powers  of  the  bank,  when,  after  protracted  negotiations,  and 
in  return  for  a  further  renewal  of  its  charter,  the  bank  sur- 
rendered its  monopoly  of  joint-stock  banking  entirely,  pro- 
vided that  no  bank  having  more  than  six  partners  might  issue 
notes  within  the  sixty-five-mile  limit  of  London. 

It  is  a  curious  point  that  the  charter  of  the  bank  never  did 
restrict  joint-stock  banking  in  its  present  accepted  form,  but 
only  the  issue  of  notes  by  joint-stock  bankers  or  banks  having 
more  than  six  partners.  Up  to  this  time  the  issue  of  notes 
by  a  bank  had  been  thought  to  be  its  main  business;  so  much 
so,  that  it  was  believed  to  be  useless  to  attempt  to  conduct  a 
bank  without  power  of  issue,  and  consequently  no  joint-stock 
bank  had  been  founded.  But  about  this  time  the  need  of  such 
institutions  began  to  be  felt,  and  the  presumed  monopoly  of 
the  Bank  of  England  was  called  in  question  —  largely  by  Mr. 
Gilbart,  the  founder  of  the  London  and  Westminster  Bank. 
The  bank  tried  to  assert  their  monopoly,  but  without  success, 
and  in  order  to  settle  the  matter  effectually,  the  following 
clause  was  inserted  in  the  act  passed  in  1833  dealing  with  the 
bank  charter: 

Be  it  therefore  declared  and  enacted,  that  any  body  politic  or 
corporate,  or  society,  or  company,  or  partnership,  although  con- 
sisting of  more  than  six  persons,  may  carry  on  the  trade  or  busi- 
ness of  banking  in  London,  or  within  sixty-five  miles  thereof,  pro- 
vided that  such  body  politic  or  corporate,  or  society,  or  company, 
or  partnership,  do  not  borrow,  owe  or  take  up  in  England,  any  sum 
or  sums  of  money  on  their  bills  or  notes  payable  on  demand,  or  at 


438  THE  ENGLISH  BANKING  SYSTEM 

any  less  time  than  six  months  from  the  borrowing  thereof,  during 
the  continuance  of  the  privileges  granted  by  this  Act  to  the  said 
Governor  and  Company  of  the  Bank  of  England. 

It  may  be  noted  that  this  act  of  1833  constituted  Bank  of 
England  notes  a  legal  tender,  except  by  the  bank  itself  or  its 
branches.  .  .  . 

PEEL'S  ACT  OR  THE  BANK   CHARTER  ACT  OF   1844,  AND 
ITS  SUSPENSIONS 

aAfter  the  renewal  of  the  charter  in  1833,  the  directors  of 
the  Bank  of  England  laid  down  as  a  principle  on  which  their 
future  operations  were  to  be  guided,  that  one-third  of  their 
liabilities  should  be  kept  in  cash  and  bullion,  and  the  remaining 
two-thirds  in  securities.  If  this  principle  had  been  acted  on, 
the  bank  would  have  been  saved  from  many  of  the  troubles 
which  shortly  assailed  it;  but  though  the  intentions  of  the 
directors  were  good,  circumstances  were  too  strong  for  them, 
and  the  actual  proportions  of  cash  and  securities  to  liabilities, 
respectively,  often  differed  materially  from  the  standard  laid 
down.  This  was  notably  the  case  during  the  periods  of  finan- 
cial pressure  which  were  experienced  in  the  years  1836 
and  1837. 

In  the  year  1839  matters  assumed  a  very  serious  aspect.  In 
the  early  part  of  this  year  the  amount  of  cash  held  by  the  bank 
was  about  one-third  of  the  amount  of  securities,  but  during 
the  year  the  amount  invested  in  securities  increased  at  the 
expense  of  the  amount  held  in  cash;  and  by  September  we  find 
that  securities  stood  at  nearly  £29,000,000,  while  the  cash  was 
reduced  to  a  tenth  of  that  figure,  and  stood  at  £2,936,000  only. 
In  order  to  avert  a  calamity  which  appeared  to  be  impending, 
the  bank  arranged  loans  in  Paris  and  Hamburg  to  the  extent 
of  between  three  and  four  millions. 

This  manifest  exhibition  of  weakness  on  the  part  of  the 
bank  led  to  the  appointment  of  a  committee  of  the  House  of 
Commons  to  inquire  into  the  matter.  The  committee  con- 
demned the  principles  on  which  the  bank  was  working,  but 
were  powerless  to  effect  any  alteration,  owing  to  the  charter 
of  the  bank  not  expiring  till  1844. 

llbid.,  pp.  28-40. 


PEEL'S  ACT  439 

On  the  expiry  of  the  charter,  however,  Sir  Robert  Peel 
brought  forward  his  famous  act  for  remodelling  the  bank, 
and  regulating  the  issues  of  the  country  banks  throughout 
England  and  Wales. 

The  act  was  passed  on  the  iQth  July,  1844,  and  continues 
without  alteration  to  the  present  day.  The  main  provisions 
enacted  thereby,  briefly  stated,  are  as  follows : 

I.  The  issue  department  and  the  ordinary  banking  depart- 
ment of  the  Bank  of  England  were  to  be  entirely  separated  as 
from  the  3 1st  August,  1844. 

II.  On  such  separation  taking  place,  securities  to  the  value 
of  £14,000,000  (including  the  [book]  debt  due  to  the  bank 
from  the  Government)   were  to  be  transferred  to  the  issue 
department,  together  with  so  much  gold  coin  and  bullion  that 
the  total  so  transferred  should  equal  the  total  amount  of  notes 
then  outstanding.     Thereafter  (with  the  exception  noted  be- 
low)   the   issue   department   must   not   issue   any   notes   in 
excess  of  a  total  of  £14,000,000  except  in  exchange  for  gold 
coin  or  bullion. 

III.  The  issue  department  might  not  at  any  time  hold  more 
silver  than  one-fourth  part  of  the  gold  held.     As  a  matter  of 
fact  the  issue  department  holds  no  silver. 

IV.  Notes  might  be  demanded  from  the  issue  department  by 
any  person  in  exchange  for  gold  at  the  rate  of  £3  i?s.  gd.  per 
standard  ounce. 

V.  If  any  banker  having  the  power  of  issue  on  the  6th  May, 
1844,  should  relinquish  such  issue,  the  issue  department  may 
be  authorised  to  increase  its  issue  of  notes  against  securities  to 
the  extent  of  two-thirds  of  the  issue  so  relinquished;  but  all 
the  profits  on  such  increased  issue  against  securities  were  to 
belong  to  the  Government. 

VI.  The  bank  must  issue  a  weekly  statement  of  the  posi- 
tion of  both  its  issue  and  banking  departments,  in  a  prescribed 
form. 

VII.  Bankers  having  the  right  to  issue  their  own  notes  on 
the  6th  May,  1844,  might  continue  such  issue  under  certain 
conditions,  and  to  an  agreed  amount;  but  no  provision  was 
made  compelling  such  bankers  to  keep  any  reserve  either  in 
cash  or  securities  against  their  issues.     If  any  issue  lapsed, 


440  THE  ENGLISH  BANKING  SYSTEM 

from  any  cause,  it  could  not  be  resuscitated;  and  no  institu- 
tions could  acquire  the  right  of  issue  in  the  future. 

VIII.  Banks  consisting  of  more  than  six  partners,  though 
within  the  sixty-five-mile  radius  of  London;  might  draw,  ac- 
cept, or  endorse  bills  of  exchange  not  being  payable  to  bearer 
on  demand. 

The  first  return  issued  by  the  bank  in  accordance  with  the 
regulations  of  the  new  act  was  that  of  the  7th  September,  1844, 
and  was  as  follows : 

ACCOUNT  OF  THE  LIABILITIES  AND  ASSETS  OF  THE  BANK  OF  ENGLAND 
For  the  Week  ending  7th  September,  1844 

DR.  ISSUE  DEPARTMENT  CR. 

Notes    issued    £28,351,295      Government   debt    11,015,100 

Other   Securities    2,084.900 

Gold    coin    and    bullion  12,657.208 

Silver    bullion    . . .' 1,694,087 


£28,351,295  £28,351,295 

DR.  BANKING  DEPARTMENT  CR. 

Proprietor's    capital....  14,553.000  Government  securities   .     14.554,834 

Rest    3,564,729      Other    securities     7,835,616 

Public   deposits    3,630,809      Notes     8,175,025 

Other  deposits   8,644,348  Gold  and  silver  coin  . .         857,765 

Seven-day     and      other 

bills    1,030,354 


£31,423,240  £31,423,240 

.  .  .  Taken  as  a  whole  the  act  has  worked  well,  and  has 
succeeded,  in  combination  with  greater  knowledge  and  fore- 
sight, in  maintaining  our  banking  system  in  a  sound  condi- 
tion. .  .  . 

The  main  point  of  contention  between  the  supporters  and 
opponents  of  the  act  lies  in  its  want  of  elasticity  in  time  of 
need.  Undef  no  circumstances  can  the  bank  increase  its 
issue  of  notes  against  securities  beyond  the  prescribed  limit, 
without  a  breach  of  the  law;  but  on  three  occasions  in  the  past 
the  law  has  been  broken,  though  with  the  consent  of  the  Gov- 
ernment, and  subsequent  confirmation  of  Parliament.  .  .  . 

We  will  now  briefly  review  the  .  .  .  occasions  on  which  the 
Bank  Act  was  suspended,  and  the  effect  of  such  suspensions. 

The  first  of  these  occasions  was  during  the  panic  in  the  year 


PEEL'S  ACT  441 

1847  —  known  as  the  "  railway  panic."  Shortly  previous  to 
this  year  a  great  accumulation  of  capital  had  led  to  a  demand 
for  new  investments,  which  were  duly  provided  for  the  public 
by  those  concerned  with  such  matters.  Added  to  this,  interest 
rates  had  ruled  low  for  some  time,  and  this  conduced  to  a 
period  of  speculative  activity.  Too  much  capital  was  put  into 
fixed  investments  —  chiefly  railways  —  and  in  one  session  of 
Parliament  sanction  was  asked  for  various  railway  schemes 
involving  a  total  capital  of  £340,000,000.  Wild  gambling  in 
railway  stocks  ensued,  credit  was  inflated  above  all  reason, 
and  then  the  turn  came.  This  was  primarily  due  to  a  bad 
harvest  and  potato  crop,  causing  a  heavy  importation  of  corn, 
and  consequent  export  of  gold. 

During  the  panic  which  ensued,  the  reserve  of  the  Bank  of 
England  fell  to  £1,600.000,  but  when  the  panic  was  at  its 
height,  the  act,  passed  only  three  years  before,  was  suspended. 
The  bank  was  authorised  to  increase  its  accommodation  to  the 
public  by  exceeding,  to  an  indefinite  extent,  the  limit  fixea  to; 
the  issue  of  notes  not  secured  against  gold.  The  effect  of  this 
suspension  of  the  act  was  immediate  and  complete.  The  fear 
that  "  there  was  not  enough  to  go  round  "  passed  from  men's 
minds.  As  a  matter  of  fact,  the  issue  on  this  occasion  did 
not  exceed  the  normal  limit,  the  mere  knowledge  that  the  bank 
was  empowered  to  exceed  this  limit  proving  sufficient  to  allay 
the  panic. 

The  second  suspension  of  the  Bank  Act  was  due  to  the 
crisis  of  1857,  a  crisis  that  was  brought  about  by  reckless 
overtrading,  and  came  upon  the  public  very  suddenly  and  with 
practically  no  warning.  .  .  . 

The  third  suspension  of  the  Bank  Act  took  place  in  I866.1 
Many  elements  of  disturbance  to  the  money  market  had  been 
in  force  during  two  or  three  preceding  years.  The  Civil  War 
in  America  had  resulted  in  gold  being  sent  to  this  country; 
but  the  stoppage  of  the  supply  of  cotton  from  America,  owing 
to  the  war,  disorganised  one  of  our  staple  national  industries, 
and  supplies  of  cotton  had  to  be  obtained  from  elsewhere  at 
high  prices,  and  paid  for  in  cash.  Hence  a  drain  of  gold  set 

1  [The  fourth  suspension  occurred  August  6, 


442  THE  ENGLISH  BANKING  SYSTEM 

in  on  a  large  scale.  In  addition,  a  large  speculation  had  been 
built  up  on  credit  in  the  stocks  and  shares  of  the  many  new 
limited  liability  companies  which  were  formed  at  that  time. 

General  uneasiness  began  to  prevail  towards  the  end  of 
1865;  in  January,  1866,  the  bank  raised  its  discount  rate  to 
8  per  cent.,  and  a  crisis  began  to  develop  rapidly.  .  .  . 

On  the  Qth  May  the  bank  rate  was  raised  to  9  per  cent.  On 
the  loth  May  the  failure  of  Overend,  Gurney,  and  Company  — 
for  upwards  of  ten  millions  —  was  announced,  and  the  bank 
rate  went  to  10  per  cent.  This  failure  was  not  made  known 
till  after  business  hours,  so  it  was  not  till  Friday,  the  nth 
May,  1866  —  known  as  "Black  Friday" — that  the  crisis 
reached  its  height. 

The  stoppage  of  this  large  house  affected  the  whole  world, 
and  general  failure  seemed  imminent,  when,  in  the  afternoon 
of  the  day  on  which  the  failure  became  known,  it  was  an- 
nounced that  the  Bank  Act  was  again  suspended,  and  calm 
began  to  take  the  place  of  mania.  But  though  the  panic  was 
allayed,  many  failures  shortly  took  place,  which  delayed  the 
quick  restoration  of  a  sense  of  security.  .  .  . 

From  the  above  brief  records  of  the  financial  tragedies  of 
the  past,  we  see  that  on  each  occasion  reckless  speculation  and 
overtrading  had  been  allowed  to  reach  a  dangerous  height  be- 
fore any  steps  were  taken  to  check  them,  and  on  each  occasion 
the  check  came  too  late.  But  we  also  see  the  marvellously 
quick  effect  which  the  suspension  of  the  act  had  on  the  situa- 
tion. .  .  . 

THE  FUNCTIONS  OF  THE  BANK  OF  ENGLAND 

1  The  distinctive  functions  of  the  Bank  of  England  consist 
in  its  acting  as : 

1.  Banker  to  the  British  Government. 

2.  Banker  to  the  joint  stock  and  private  banks. 

3.  (a)  Sole  possessor  of  the  right  to  issue  notes  which  are 
legal  tender  in  England;  (b)  sole  possessor,  among  joint  stock 
banks  with  an  office  in  London,  of  the  right  to  issue  notes  at  all. 

1  Adapted  from  Hartley  Withers,  The  English  Banking  System,  Pub- 
lications of  the  National  Monetary  Commission,  Senate  Document  No. 
492,  6ist  Congress,  2nd  Session,  pp.  3-64. 


FUNCTIONS  OF  THE  BANK  OF  ENGLAND  443 

4.  Provider  of  emergency  currency. 

5.  Keeper  of  the  gold  reserve  for  British  banking. 

6.  Keeper  of  the  gold  reserve  which  is  most  readily  avail- 
able for  the  purposes  of  international  banking. 

These  various  functions  fit  into  and  supplement  one  another, 
and  though  their  diversity  is  sometimes  pointed  to  as  throw- 
ing too  much  responsibility  onto  one  institution,  it  in  fact  en- 
ables the  bank  to  carry  out  its  duties  with  extraordinary  ease, 
and  with  the  least  possible  disturbance  to  the  financial  com- 
munity. By  the  fact  that  it  keeps  the  balances  of  the  other 
banks,  the  Bank  of  England  is  enabled  to  conduct  the  payment 
of  the  interest  on  the  British  debt  largely  by  transfers  in  its 
books.  By  the  fact  that  it  keeps  the  balances  of  the  Govern- 
ment and  has  the  monopoly  of  the  legal-tender  note  issue,  the 
Bank  has  a  great  prestige  in  the  eyes  of  the  general  public, 
which  it  communicates  to  the  other  banks  which  bank  with  it. 
There  is  an  impression  that  the  Government  is  always  behind 
the  bank,  and  that  the  bank  is  always  behind  the  other  banks, 
and  this  feeling  has  certainly  done  much  to  foster  the  confi- 
dence of  the  British  public  in  its  banking  system. 

A  credit  in  the  books  of  the  Bank  of  England  has  come  to 
be  regarded  as  just  as  good  as  so  much  gold;  and  the  other 
banks,  with  one  exception,  habitually  state  their  "  cash  in  hand 
and  at  the  Bank  of  England  "  as  one  item  in  their  balance 
sheets,  as  if  there  were  no  difference  between  an  actual  holding 
of  gold  or  legal  tender  and  a  balance  at  the  Bank  of  England. 
It  thus  follows  at  times  when  an  increase  of  currency  is  de- 
sirable, it  can  be  expanded  by  an  increase  in  the  balances  of 
the  other  banks  at  the  Bank  of  England,  since  they  thus  be- 
come possessed  of  more  cash  to  be  used  as  the  basis  of  credit. 
For  currency  in  England  chiefly  consists  of  cheques,  and 
customers  who  apply  to  the  banks  for  accommodation,  by  way 
of  discount  or  advance,  use  it  by  drawing  a  cheque  which  is 
passed  on  and  so  creates  a  deposit ;  and  expansion  of  currency 
thus  consists  chiefly  in  expansion  of  banking  deposits.  This 
expansion  is  only  limited  by  the  proportion  between  deposits 
and  cash  which  the  banks  think  fit  to  keep,  and  as  long  as 
they  can  increase  their  cash  by  increasing  their  credit  in  the 
Bank  of  England's  books  the  creation  of  currency  can  proceed 


444  THE  ENGLISH  BANKING  SYSTEM 

without  let  or  hindrance.  Their  balances  can  be  increased  by 
borrowing  from  the  Bank  of  England,  which  is  generally 
carried  out  not  by  the  banks  themselves  but  by  their  customers 
from  whom  they  have  called  in  loans,  and  the  Bank  of  Eng- 
land is  thus  enabled  to  provide  emergency  currency  with  great 
ease,  by  means  of  loans  and  discounts  which  are  used  to  swell 
the  balances  of  the  other  banks,  which  thus  show  an  increase 
of  the  cash  at  the  Bank  of  England  which  they  use  as  a  basis 
for  credit  operations.  The  elasticity  of  the  system  is  thus 
remarkable,  and  the  merchants  and  bill  brokers  of  London 
can  by  taking  approved  security  to  the  Bank  of  England,  in- 
crease the  basis  of  English  credit  in  a  few  minutes  by  bor- 
rowing. 

1.  Examining  these  functions  of  the  Bank  of  England  in 
closer  detail  we  find  that  its  first  and  most  obvious  one,  which 
originally  brought  it  into  being,  of  financing  the  British  Gov- 
ernment and  acting  as  its  banker,  is  now  perhaps  its  least  diffi- 
cult and  important  duty.     Apart  from  the  prestige  which  it 
thus  acquires  and  its  close  touch  with  the  Government  and 
the  officials  of  the  Treasury,  the  bank's  position  as  govern- 
ment banker  is  of  little  direct  material  advantage.     Its  duties 
as  such,  besides  the  normal  relation  between  a  bank  and  a 
customer,  consist  chiefly  in  making  advances  to  the  Treasury 
in  the  shape  of  "  deficiency  advances  "  when  the  government 
balances  are  too  low  to  admit  of  the  payment  of  the  quarterly 
interest  on  the  British  debt  without  replenishment,  or  against 
"  ways  and  means  "  advances  at  times  when  the  revenue  is 
coming  in  more  slowly  than  government  expenditure  is  pro- 
ceeding.    It  also,  when  the  Government  has  to  borrow  to  a 
greater  extent,  manages  its  issues  of  Treasury  bills,  or  any  loan 
operation  that  the  Government  may  have  to  undertake. 

2.  The  second  of  the  Bank  of  England's  distinctive  func- 
tions —  its  acting  as  banker  to  the  rest  of  the  English  banking 
community  —  is  the  one  which  throws  upon  it  its  most  serious 
responsibilities  and  gives  it  most  of  its  actual  power  and  ease 
in  working.     The  Government  gives  it  prestige  in  the  eyes  of 
the   multitude,   which   considers   that   governments   are   om- 
nipotent;  the  other  banks   give   it  the  power  of  providing 
emergency  currency  by  making  entries  in  its  books,  and  so 


FUNCTIONS  OF  THE  BANK  OF  ENGLAND  445 

acting  as  the  easily  efficient  centre  of  a  banking  system  in  which 
elasticity  and  the  economy  of  gold  are  carried  to  a  perfection 
which  is  almost  excessive.  Nevertheless,  it  pays  heavily  for 
its  apparently  privileged  position  as  bankers'  bank.  At  first 
sight  it  would  appear  that  these  customers,  keeping  a  regular 
balance  of  twenty-odd  millions,  which  varies  little  and  on 
which  the  Bank  of  England  pays  no  interest,  were  a  source  of 
comfortable  income  and  no  anxiety  to  it.  But  in  the  first  place 
it  is  obvious  that  a  liability  which  is  regarded  as  cash  by  the 
rest  of  the  banking  community  requires  special  treatment  by 
its  custodian,  and  in  practice  it  is  so  specially  treated  that  the 
Bank  of  England  maintains  a  proportion  of  cash  to  liabilities 
which  is  fully  twice  as  high  as  that  of  the  strictest  of  the  other 
banks.  This  proportion  rarely  is  allowed  to  fall  below  33 
per  cent,  and  generally  ranges  between  40  and  50  per  cent., 
and  it  need  not  be  said  that  this  high  level  of  cash  holding  tells 
heavily  on  the  earning  power  of  the  Bank  of  England. 
Moreover,  it  is  its  position  as  bankers'  bank  that  exposes  the 
Bank  of  England  to  the  responsibility  of  maintaining  the  gold 
reserve  for  English  banking  and  being  prepared  to  meet,  in 
gold,  any  draft  on  London  that  any  one  abroad  who  has  ac- 
quired or  borrowed  the  right  to  draw  wishes  to  turn  into  metal 
to  be  shipped  to  a  foreign  country. 

The  amount  of  the  bankers'  balances  is  not  separately  stated, 
but  is  wrapped  up  in  the  total  of  the  other  deposits  in  the  Bank 
of  England's  weekly  return.  It  is  believed  to  average  about 
22  millions-  in  these  days,  and  it  is  often  contended  that  /aluable 
light  would  be  thrown  on  the  monetary  position  if  this  item 
were  separated  from  the  balances  of  the  other  customers  of 
the  bank.  Many  of  the  outer  bankers  are  in  favor  of  this 
change,  but  there  is  a  serious  practical  objection  to  it,  in  that 
a  dangerous  impression  might  be  created  in  the  public  mind 
if  at  any  time  it  were  seen  that  the  bank's  cash  reserve  was 
below  its  liability  to  its  banking  customers;  and  the  separate 
publication  of  the  bankers'  balances  might  thus  check  the 
readiness  with  which  the  Bank  of  England  creates  emergency 
credit.  Another  suggestion  that  is  sometimes  made  by  the 
many  critics  of  the  existing  order  of  things  in  English  bank- 
ing is  that  the  banks  should  keep  their  cash  reserves  them- 


446  THE  ENGLISH  BANKING  SYSTEM 

selves;  but  this  very  revolutionary  change  would  deprive  the 
system  of  its  two  great  advantages,  a  centralised  organisation 
with  a  centre  which  specialises  on  the  duties  involved  by  acting 
as  centre,  and  the  extreme  elasticity  with  which  the  present 
arrangements  work.  At  the  same  time  it  must  be  admitted 
that  the  system  by  which  the  other  banks  treat  their  balances 
at  the  Bank  of  England  as  cash  leads  to  the  existence  of  a 
vast  amount  of  "  cash  "  in  England  which  on  being  looked 
into  is  found  to  consist  of  paper  securities  or  promises  to 
pay. 

3.  The  Bank  of  England's  monopoly  of  note  issue,  which 
once  gave  it  the  monopoly  of  joint-stock  banking  in  London, 
is  now  a  matter  of  comparatively  minor  importance,  owing  to 
the  change  in  English  banking  habits  by  which  the  cheque  has 
ousted  the  bank  note  for  the  purpose  of  daily  commercial  pay- 
ments, and  the  regulations  which  were  imposed  on  the  note 
issue  by  the  Bank  Act  of  1844.  This  monopoly  was  con- 
ferred on  the  bank  in  1706  and  was  maintained  until  1826, 
when  the  implied  monopoly  in  joint-stock  banking  was  re- 
stricted to  a  sixty-five-mile  radius  around  London.  In  1833 
joint-stock  banks  were  established  in  London  itself,  since  it 
had  been  discovered  that  the  Bank  of  England's  alleged 
monopoly  only  reserved  to  it  the  privilege  of  note  issue,  and 
the  private  bankers  in  London  had  already  found  that  it  was 
more  convenient  to  banker  and  customer  to  work  by  the  system 
of  deposit  and  cheque. 

The  development  of  this  system  was  quickened  by  the  pro- 
visions of  Peel's  act  of  1844,  which,  under  the  influence  of 
banking  disasters  that  had  arisen  out  of  reckless  note  issuing 
by  private  banking  firms  in  the  counties,  laid  down  an  iron 
rule  for  the  regulation  of  note  issues  in  England.  None  of 
the  other  note  issuers  were  allowed  to  increase  their  issues 
under  any  circumstances,  and  the  Bank  of  England,  for  every 
additional  note  issued  beyond  £14,000,000,  was  to  hold  metal 
in  its  vaults.  Under  the  terms  of  Peel's  act  one-fifth  of  this 
metal  might  be  silver,  and  in  the  early  returns  issued  by  the 
bank  under  the  act  a  certain  amount  of  silver  is  found  among 
the  assets  of  the  issue  department.  But  since  1853.  no  silver 
has  been  held  in  the  issue  department  of  the  bank,  and  in  1897, 


FUNCTIONS  OF  THE  BANK  OF  ENGLAND  447 

when  the  influence  of  the  bimetallists  on  the  existing  Govern- 
ment led  to  a  proposal  that  the  proportion  of  silver  allowed 
by  law  should  be  held  by  the  bank  as  backing  for  its  note  issue, 
public  opinion  expressed  itself  so  vigorously  that  the  sugges- 
tion was  promptly  buried.  The  bank's  fiduciary  note  issue, 
thus  fixed  at  £14,000,000,  was  only  allowed  to  increase  by  the 
lapse  of  the  issues  of  the  existing  issuers,  the  bank  being  em- 
powered to  increase  it  by  two-thirds  of  the  amount  lapsed. 
The  lapsing  process  has  proceeded  steadily  by  the  amalgama- 
tion of  country  banks  with  banks  which  have  London  offices 
and  so  are  prohibited  by  the  bank's  monopoly.  And  the 
bank's  fiduciary  issue  has  thus  been  raised  from  the  original 
£14,000,000  to  £18,450,000.  Above  this  line  it  can  not  go 
except  by  means  of  the  suspension  of  the  Bank  Act,  which  has 
been  found  necessary  occasionally  in  the  past.  The  English 
currency  system  is  thus,  as  far  as  the  law  can  rule  it,  entirely 
inelastic,  but  it  has  already  been  shown  that  even  when  the 
law  of  1844  was  passed,  the  cheque  currency,  over  which  the 
law  exercises  no  restriction,  was  already  driving  out  the  note, 
and  banks  without  any  right  of  note  issue  had  been  eleven 
years  established  in  London.  The  Bank  of  England's  note 
issue  is  now  chiefly  used  by  other  banks  as  "  till  money,"  or 
part  of  the  store  of  legal-tender  cash  they  keep  to  meet  de- 
mands on  them.  It  has  thus  become  part  of  the  basis  of 
credit  in  England,  since  the  other  banks  roughly  base  their 
operations  on  their  holding  of  cash  in  hand  and  at  the  Bank 
of  England.  Their  cash  at  the  Bank  of  England  has  already 
been  discussed  above;  their  cash  in  hand  consists  of  coin  and 
notes,  and  since  the  latter  have  thus  become  part  of  the  founda- 
tion on  which  the  deposit  liabilities  of  the  other  banks  are 
based,  there  is  reasonable  ground  for  the  contention  often  put 
forward  by  practical  expert  critics  of  the  English  system,  that 
the  fiduciary  note  issue  should  be  reduced  by  the  repayment  by 
the  Government  of  the  whole  or  part  of  a  government  debt  of 
£11,000,000  to  the  bank,  which  backs  the  greater  part  of  it, 
and  its  replacement  by  gold.  It  is  evident  that  the  amount  of 
metallic  backing  for  a  note  issue  which  is  intended  to  circulate 
as  currency  is  a  different  matter  from  that  required  in  the  case 
of  a  note  issue  which  is  held  by  bankers  as  a  reserve  and  used 


448  THE  ENGLISH  BANKING  SYSTEM 

by  them  as  a  foundation  for  a  pyramid  of  credit  opera- 
tions. 

4.  By  the  ease  with  which  the  Bank  of  England  provider 
emergency  currency,  it  gives  the  English  banking  system  the 
great  advantage  of  extreme  elasticity  and  adaptability;  and  it 
is  enabled  to  do  this  by  the  fact  that  it  acts  as  banker  to 
the  other  banks,  and  that  every  credit  which  they  have  in  its 
books  is  regarded  by  them  and  by  the  rest  of  the  community 
as  "  cash  "  to  be  taken  as  practically  equal  to  so  much  gold. 
This  cash  at  the  Bank  of  England  in  the  hands  of  the  rest  of 
bankers  can  be  multiplied  as  rapidly  as  the  Bank  of  England 
is  prepared  to  make  advances,  and  as  the  mercantile  and  finan- 
cial community  can  bring  it  bills  for  discount  or  securities  to 
be  borrowed  on.  There  is  no  legal  restriction  of  any  sort  or 
kind,  and  the  close  relations  between  the  bank  and  its  borrow- 
ing customers  enable  the  necessary  operations  to  be  carried 
through  with  a  celerity  which  is  unrivalled,  at  any  rate  in  the 
eastern  hemisphere.  The  process  works  as  follows :  In  every 
English  bank  balance  sheet  there  will  be  found  an  item  among 
the  assets  "  cash  at  call  or  short  notice,"  though  in  a  few  cases 
the  slovenly  habit  is  adopted  of  including  this  entry  along 
with  the  cash  in  hand.  This  "  cash,"  as  it  is  called,  really 
consists  chiefly  of  loans  made  by  the  banks  to  the  discount 
houses,  and  regarded  by  the  banks  as  the  most  liquid  of  their 
resources.  As  such,  it  is  at  once  made  use  of  when  for  any 
reason,  such  as  the  many  payments  which  have  to  be  made  on 
quarter  days,  or  at  the  end  of  the  half  year  when  the  prepara- 
tion of  balance  sheets  by  firms  and  companies  require  an 
abnormal  amount  of  cash  for  more  or  less  ornamental  pur- 
poses, the  banks  are  subjected  to  extra  pressure  by  their 
customers,  who  both  withdraw  actual  currency  from  them  for 
smaller  payments,  and  require  advances  in  order  to  show  cash 
with  bankers  in  their  balance  sheets. 

The  banks  in  order  to  meet  this  pressure,  and  at  the  same 
time  to  preserve  an  adequate  amount  of  cash  in  their  own 
statements,  call  in  their  loans  from  the  discount  houses;  the 
discount  houses,  at  a  point,  can  only  repay  them  by  borrowing 
from  the  Bank  of  England  and  transferring  the  credit  raised 
with  it  to  the  bankers,  whose  cash  at  the  Bank  of  England  is 


FUNCTIONS  OF  THE  BANK  OF  ENGLAND  449 

thus  increased.  This  book  entry  takes  the  place  in  their  bal- 
ance sheets  of  the  legal-tender  cash  that  their  customers  have 
withdrawn,  and  is  used  as  the  basis  for  the  increased  deposits 
that  have  been  created  by  the  loans  of  the  bankers  to  their 
customers  for  ornamental  purposes.  Similarly  at  the  time  of 
year  when  the  transfer  of  the  taxes  to  the  Government's  bal- 
ance reduces  the  cash  at  the  Bank  of  England  held  by  the  other 
banks  the  gap  is  filled  by  the  loans  made  by  the  Bank  of 
England  to  the  customers  of  the  other  banks.  In  short,  by 
discounting  and  making  advances  the  Bank  of  England  can 
at  any  time  create  book  credits,  which  are  regarded  as  cash  by 
the  English  banking  community,  and  on  which  the  latter  can 
base  the  credits  which  give  the  right  to  draw  cheques,  which 
are  the  most  important  part  of  the  English  currency.  The 
extent  to  which  the  Bank  of  England  can  create  this  credit  is  a 
matter  for  its  own  discretion,  but  any  creation  of  it  diminishes 
the  proportion  that  it  shows  in  its  own  weekly  returns  between 
its  reserve  and  liabilities.  Consequently  when  it  is  applied 
to  for  amounts  which  bring  that  proportion  too  low  the  Bank 
of  England  has  to  take  steps  to  reinforce  its  cash  reserve. 

5.  It  has  been  shown  that  the  Bank  of  England  keeps  the 
balances  of  the  other  banks,  and  from  this  it  follows  that  the 
latter  look  to  it  for  gold  or  notes  at  times  when  the  local 
commercial   community   requires   an   extra   supply.     At   the 
end  of  every  month,  especially  at  the  ends  of  the  quarters  or 
at  times  of  national  holidays,  the  bank's  note  circulation  ex- 
pands and  coin  is  taken  from  it.     The  duty  is  thus  thrown 
upon  it  of  keeping  an  adequate  supply  of  cash  for  home  pur- 
poses, and,  as  has  been  already  stated,  its  normal  proportion 
of  cash  to  liabilities  is  very  much  higher  than  that  of  the 
other  banks.     But  these  movements  are  tidal  and  regular,  and 
though  times  of  active  trade  increase  slightly  the  demand  for 
coin  and  note  currency  in  England,  the  extensive  and  ever- 
growing use  of  the  cheque  reduces  the  importance  of  this  part 
of  the  bank's  duties. 

6.  Much  more  important  is  the  Bank  of  England's  duty  as 
custodian  of  the  gold  store  for  international  banking.     London 
is  the  only   European  centre  which   is  always  prepared  to 
honor  its  drafts  in  gold  immediately  and  to  any  extent.     Con- 


450  THE  ENGLISH  BANKING  SYSTEM 

sequently  the  Bank  of  England  has  to  be  prepared  to  meet 
demands  on  it  at  any  time  from  abroad,  based  on  credits  given 
to  foreigners  by  the  English  banking  community,  and  it  has 
thus  to  observe  the  signs  of  financial  weather  in  all  parts  of  the 
world  and  to  regulate  the  price  of  money  in  London  so  that 
the  exchanges  may  not  be  allowed  to  become  or  remain  ad- 
verse to  a  dangerous  point.  The  difficulties  of  this  task  are 
increased  by  the  extent  to  which  the  English  banking  com- 
munity works  independently  of  it,  by  accepting  and  discount- 
ing finance  paper,  and  giving  foreigners  credits  at  rates  which 
encourage  their  further  creation.  For  the  low  and  wholly 
unregulated  proportion  of  cash  to  liabilities  on  which  English 
banking  works,  enables  the  other  banks  to  multiply  credits 
ultimately  based  on  the  Bank  of  England's  reserve,  leaving  the 
responsibility  for  maintaining  the  reserve  to  the  bank.  This 
it  does  by  raising  its  rate  when  necessary,  and  so,  if  it  has  con- 
trol of  the  market  and  its  rate  is  "  effective  " —  a  phrase  which 
will  be  explained  later  —  raising  the  general  level  of  money 
rates  in  London. 

When  its  rate  is  not  effective,  the  Bank  of  England  finds  it- 
self obliged  to  intervene  in  the  outer  money  market  —  con- 
sisting of  the  other  banks  and  their  customers  —  and  control 
the  rates  current  in  it.  This  it  does  by  borrowing  some  of 
the  floating  funds  in  this  market,  so  lessening  their  supply  and 
forcing  up  the  price  of  money.  By  means  of  this  borrowing  it 
diminishes  the  balances  kept  with  it  by  the  other  banks,  either 
directly  or  indirectly  —  directly  if  it  borrows  from  them,  in- 
directly if  it  borrows  from  their  customers  who  hand  the 
advance  to  it  in  the  shape  of  a  cheque  on  them.  The  result 
is  that  so  much  of  the  "  cash  at  the  Bank  of  England,"  which 
the  English  banking  community  uses  as  part  of  its  basis  of 
credit,  is  wiped  out.  money  —  which  in  London  generally 
means  the  price  at  which  the  bankers  are  prepared  to  lend  for 
a  day  or  for  a  short  period  to  the  discount  houses  —  becomes 
dearer,  the  market  rate  of  discount  consequently  tends  to  ad- 
vance, the  foreign  exchanges  move  in  favor  of  London,  and 
the  tide  of  gold  sets  in  the  direction  of  the  Bank  of  England's 
vaults,  and  it  is  enabled  to  replenish  its  reserve  or  check  the 
drain  on  it.  That  the  Bank  of  England  should  have  to  go 


FUNCTIONS  OF  THE  BANK  OF  ENGLAND  451 

through  this  clumsy  ceremony  of  borrowing  money  that  it  does 
not  want,  in  order  to  deprive  the  outer  market  of  a  surplus 
which  depresses  discount  rates  in  a  manner  that  is  dangerous 
owing  to  its  effect  on  the  foreign  exchanges,  arises  from  the 
want  of  connection  between  bank  rate  and  market  rate.  In 
former  days  the  London  money  market  never  had  enough 
money  to  work  without  help  from  the  Bank  of  England. 
Bagehot,  in  his  great  work  on  Lombard  Street,  published  in 
1873,  says  that  "  at  all  ordinary  moments  there  is  not  money 
enough  in  Lombard  Street  to  discount  all  the  bills  in  Lombard 
Street  without  taking  some  money  from  the  Bank  of  Eng- 
land." 

As  long  as  this  was  so,  bank  rate  —  the  price  at  which  the 
bank  would  discount  bills  —  was  at  all  times  an  important 
influence  on  the  market  rate.  Since  then,  however,  the  busi- 
ness of  credit  making  has  been  so  quickly  and  skillfully  ex- 
tended that  Lombard  Street  is  frequently  able  to  ignore  bank 
rate,  knowing  that  it  will  easily  be  able  to  supply  its  needs  from 
the  other  banks,  at  rates  which  are  normally  below  it.  Cur- 
rency in  England  consists  of  cheques  drawn  against  deposits 
which  are  largely  created  by  the  loans  and  discounts  of  the 
other  banks.  There  is  no  legal  limit  whatever  on  the  extent 
to  which  these  loans  and  discounts  can  be  multiplied,  and  the 
only  limits  imposed  are  those  of  publicity,  which  is  applied 
rarely  in  all  cases  and  in  some  not  at  all,  and  of  the  prudence 
with  which  the  banks  conduct  their  business.  Hence  it  fol- 
lows that  competition  between  the  banks  often  impels  them  to 
continue  to  make  advances  or  discount  bills  at  low  rates  when 
the  Bank  of  England,  as  custodian  of  the  English  gold  reserve, 
thinks  it  advisable  in  the  interests  of  the  foreign  exchanges  to 
impose  a  higher  level.  This  it  does  by  borrowing  some  of 
the  credit  manufactured  by  the  other  banks,  in  order  to  create 
artificial  scarcity  of  money,  and  make  its  own  official  rate 
effective. 

It  thus  appears  that  the  Bank  of  England's  official  rate  is 
often  through  long  periods  a  mere  empty  symbol,  bearing  no 
actual  relation  to  the  real  price  of  money  in  London :  and  only 
becomes  effective,  and  a  factor  in  the  monetary  position  ( I ) 
when  the  trade  demand  for  credit  is  keen  enough  to  tax  the 


452  THE  ENGLISH  BANKING  SYSTEM 

credit-making  facilities  of  the  other  banks  to  their  full  extent, 
(2)  when  the  payment  of  taxes  transfers  large  sums  from  the 
other  banks  to  the  Government's  account  at  the  Bank  of  Eng- 
land, so  reducing  the  "  cash  at  the  bank  "  on  which  they  build 
credit  operations,  and  (3)  when,  owing  to  foreign  demands 
for  gold,  the  Bank  of  England  takes  measures,  by  borrowing, 
to  restrict  credits  in  the  open  market  and  to  make  its  rate 
effective.  In  other  respects  its  official  rate  differs  materially 
from  the  rates  quoted  by  ordinary  dealers  in  credit.  It  does 
not  fluctuate  according  to  the  supply  and  demand  for  bills,  but 
is  regularly  fixed  once  a  week  at  the  meetings  of  the  Bank  of 
England  court  on  Thursday  morning.  It  is  extremely  rare 
for  any  change  to  be  made  in  the  Bank  of  England  rate  on 
any  day  except  Thursday.  Instances  occur  rarely  when  some 
sudden  change  of  position  makes  it  essential,  as  at  the  end  of 
1906,  when  the  bank  rate  was  raised  to  6  per  cent,  on  a  Friday 
morning.  In  normal  times  the  rate  which  is  fixed  on  one 
Thursday  is  maintained  until  the  next,  though  the  rate  is  only 
a  minimum  and  the  Bank  of  England  occasionally  takes  ad- 
vantage of  this  fact  and  refuses  to  discount  at  its  minimum, 
which  still  remains  ostensibly  the  bank  rate,  while  the  bank 
actually  makes  a  rather  higher  charge,  which  is  usually  made 
the  official  rate  on  the  next  Thursday. 

But  it  must  not  be  supposed  that  when  bank  rate  is  inef- 
fective the  Bank  of  England  is  doing  no  business.  It  dis- 
counts bills  and  makes  advances  at  market  rates  at  its  branches, 
and  also  at  its  head  office  to  its  private  customers.  Bank  rate 
may  be  described  as  the  price  at  which  the  bank  is  prepared 
to  discount  in  its  official  capacity  as  centre  of  the  London 
market,  and  it  is  because  appeal  is  only  made  in  exceptional 
circumstances  to  the  bank  to  provide  credit  in  this  capacity 
that  bank  rate  is  often  ineffective. 


THE  JOINT-STOCK  BANKS 

The  most  obvious  function  of  the  joint-stock  banks  of  Eng- 
land is  the  business  of  taking  care  of  money  for  customers 
and  meeting  cheques  drawn  against  their  balances.  Custom- 
ers place  money  with  them  either  on  current  or  deposit  ac- 


THE  JOINT  STOCK  BANKS  453 

count.  On  current  account  it  can  be  withdrawn  at  any  time 
and  earns,  as  a  rule,  no  interest.  Many  banks  make  it  a  condi- 
tion that  unless  the  current  account  is  maintained  at  a  certain 
figure,  generally  £100,  a  charge  shall  be  made  for  keeping  it. 
A  usual  charge  is  £i  $s.  od.  each  half  year,  but  arrangements 
vary  according  to  the  terms  agreed  with  different  customers, 
and  the  keen  competition  now  prevalent  enables  many  to  ob- 
tain the  convenience  of  a  bank  account  for  nothing.  Sums 
left  on  deposit  are  generally  placed  for  a  week  or  longer,  and 
if  placed  for  a  week  the  rate  paid  on  them  by  the  banks  is 
generally  1^2  per  cent,  below  bank  rate. 

Out  of  this  function  of  meeting  checks  drawn  by  customers 
against  the  sums  deposited  has  grown  the  banker's  chief  duty, 
which  is  now  the  provision  of  cheque  currency  for  the  mercan- 
tile and  financial  community.  Currency  in  England  consists 
of  coins,  notes,  and  cheques.  The  note  issues  are  almost  ob- 
solete as  currency,  the  Bank  of  England's  being  used  chiefly 
as  reserve  by  the  other  banks,  while  the  issues  of  the  country 
banks  are  so  small  as  to  be  negligible.  Most  of  the  commercial 
and  financial  transactions  of  England  to-day  are  settled  by 
cheques  drawn  on  the  banks  by  their  customers.  These 
cheques  are  not  legal  tender,  since  it  would  obviously  be  im- 
possible that  a  cheque  drawn  by  an  individual  on  a  bank  could 
be  legally  made  acceptable  by  a  creditor  whether  he  wished 
to  take  it  or  not. 

There  is  no  legal  obligation  of  any  sort  on  them  to  maintain 
any  regular  proportion  between  cash  and  liabilities,  and  as  their 
position  in  this  respect  is  only  subjected  to  occasional  publicity 
they  are  not  obliged  to  consider  even  the  effect  upon  their  cus- 
tomers of  any  considerable  variation  in  the  proportion  between 
cash  and  liabilities  which  they  keep.  The  system  thus  works 
with  extreme  elasticity  and  banking  facilities  can  be  provided 
in  England  with  extraordinary  ease.  It  has  of  late  years  been 
frequently  contended  that  the  ease  and  elasticity  with  which  it 
works  have  carried  the  English  banking  machinery  to  a  some- 
what extreme  length  in  the  matter  of  the  economy  of  gold  and 
legal  tenders  and  the  extent  of  the  credit  pyramid  which  it 
builds  up  on  them.  After  the  crisis  of  1890,  Lord  Goschen 
seems  to  have  been  strongly  imbued  with  the  conviction  that 


454  THE  ENGLISH  BANKING  SYSTEM 

the  system  had  been  carried  too  far.  He  therefore  urged 
upon  the  London  banks  that  they  should  make  a  monthly  state- 
ment of  their  position,  and  this  suggestion  was  adopted  by  the 
majority  of  them.  The  result  was  that  they  published  a 
monthly  statement  showing  how  they  stood  on  one  day  at  the 
end  of  each  month,  and  it  thus  followed  that  on  one  day  at 
the  end  of  each  month  the  banks  showed  a  proportion  of  cash 
to  liabilities  which  they  considered  sufficiently  adequate  to 
stand  the  light  of  publicity.  But  the  system  has  long  been 
seen  to  be  faulty,  and  a  certain  amount  of  abuse  has  grown  up 
round  it.  It  is  strongly  suspected,  for  example,  that  some  of 
the  banks  which  publish  these  statements  make  preparations  for 
them  by  calling  in  loans  or  reducing  their  discounts  for  the 
day  on  which  the  statements  are  drawn  up.  As  far  as  this  is 
done  the  statement  is  to  a  certain  extent  misleading,  and  this 
practice  of  "  window  dressing,"  as  it  is  called  in  Lombard 
Street,  has  been  subject  to  frequent  criticism,  so  much  so  that 
one  of  the  leading  London  banks  —  the  London  and  County  — 
adopted  early  in  1908  the  practice  of  showing  its  daily  average 
cash  holding,  thus  demonstrating  that  it  was  not  in  the  habit 
of  preparing  a  statement  which  did  not  represent  its  position 
fairly  throughout  the  month.  It  has  been  stated  by  a  presi- 
dent of  the  English  Bankers'  Institute  that  the  proportion  of 
cash  to  liabilities  shown  by  country  banks  ranges  down  to  a 
point  as  low  as  2.2  per  cent.  No  one  can  contend  that  this  is 
an  adequate  cash  basis  for  banking  to  work  on,  and  as  long  as 
certain  members  of  the  banking  community  conduct  their  busi- 
ness on  these  lines  an  obvious  hardship  is  involved  on  those 
which  keep  a  more  prudent  and  strong  reserve  of  cash.  It  is 
contended  by  the  big  strong  banks  that  their  smaller  brethren 
compete  with  them  by  providing  more  credit  than  they  have 
any  right  to  create,  relying  on  their  assistance  in  times  of 
difficulty. 

Apart  from  this  danger  of  the  over-multiplication  of  credit 
on  an  inadequate  cash  basis,  the  complete  absence  of  any  legal 
or  other  restrictions  on  the  operations  of  English  banking  en- 
.ables  it  to  work  with  extraordinary  ease  and  readiness.  As 
long  as  good  unpledged  security,  whether  in  the  form  of  bills 
of  exchange,  commodities,  or  Stock  Exchange  securities,  are 


THE  JOINT  STOCK  BANKS  455 

available  in  the  hands  of  customers  the  banks  can  advance 
against  them  to  any  extent  that  they  consider  prudent.  Pru- 
dence dictates  in  the  case  of  a  great  majority  of  them  that  a 
certain  proportion  of  cash  to  liabilities  shall  be  maintained,  but, 
as  was  shown  above  in  dealing  with  the  Bank  of  England,  the 
cash  of  English  banking  consists  partly  of  credits  with  the 
Bank  of  England.  These  credits  with  the  Bank  of  England, 
and  consequently  the  cash  credits  of  English  banking,  can  be 
multiplied  as  rapidly  as  the  Bank  of  England  is  prepared  to 
make  advances  or  discount  bills,  and  so  give  credit  in  its  books. 
The  Bank  of  England  must  publish  its  account  weekly,  and 
it  watches  over  its  proportion  of  cash  to  liabilities  with  a 
vigilance  which  is  greater  than  that  of  the  rest  of  the  banking 
community  as  a  whole.  Nevertheless,  its  prudence  in  this 
respect  is  the  only  restriction  on  it,  and  we  thus  arrive  at  the 
conclusion  that  the  chief  function  of  the  English  joint  stock 
banks,  that  of  providing  the  mercantile  community  with  cur- 
rency and  credit,  can  be  carried  out  to  any  extent  as  long  as 
their  customers  have  security  to  offer  and  their  proportion  of 
cash  remains  adequate  to  their  sense  of  prudence.  And 
further,  their  proportion  of  cash  can  be  increased  as  rapidly 
as  the  Bank  of  England  is  prepared  to  make  advances,  which 
it  can  and  does  to  an  extent  which  again  is  only  limited  by  its 
own  prudence. 

Besides  this  absence  of  outside  regulation,  the  English 
monetary  system  is  also  distinguished  by  a  remarkable  lack  of 
cohesion  and  co-operation  among  the  members  of  its  own 
body.  Except  to  a  certain  extent  in  the  country  districts, 
where  the  rates  allowed  to  depositors  and  charged  to  customers 
are  to  a  certain  extent  a  matter  of  convention,  English  banking 
works  almost  entirely  at  the  mercy  of  very  keen  internal  com- 
petition. This  extreme  development  of  competition  leaves 
the  market  liable  to  pronounced  depression  in  rates  at  times 
when  slackness  of  trade  or  other  causes  decrease  the  demand 
for  credits.  At  these  times  the  adroit  bill  brokers  and  dis- 
count houses,  which  are  in  some  respects  the  most  important 
borrowing  customers  of  the  banks  in  London,  are  enabled  by 
the  use  of  this  weapon  of  competition  to  obtain  loans  from  the 
banks  at  rates  which  are  often  below  the  price  that  the  bankers 


456  THE  ENGLISH  BANKING  SYSTEM 

are  paying  to  their  depositors.  Hence,  it  follows  that  in 
these  times  of  monetary  ease  the  credit  machine  goes  on  turn- 
ing out  its  product  at  rates  which  are  quite  unremunerative 
and  have  a  detrimental  effect  on  the  market  rate  of  discount, 
and  so  on  the  foreign  exchanges,  thus  increasing  the  difficul- 
ties of  the  Bank  of  England,  which  at  these  times  of  extreme 
ease  is  without  any  control  of  the  position.  Against  this  weak- 
ness of  the  system,  however,  must  be  set  the  advantage  which 
the  unrestricted  and  fiercely  competitive  manufacture  of  credit 
confers  on  the  mercantile  and  trading  community. 

A  few  words  should  be  said  concerning  the  form  of  cheques 
with  which  the  English  banks  provide  their  customers  as  cur- 
rency. Legally  a  cheque  is  a  bill  of  exchange  drawn  on  a 
bank  and  payable  on  demand.  That  is  to  say,  it  is  an  order 
signed  by  a  customer  of  the  bank  directing  it  to  pay  a  certain 
sum  to  another  party  or  to  himself.  The  form,  however,  can 
be  varied  in  various  methods,  increasing  or  diminishing  the  ease 
with  which  the  cheque  can  be  turned  into  cash.  The  cheque 
can  be  made  payable  to  A  B  or  bearer,  and  in  this  form  can  be 
taken  to  the  bank  drawn  on  and  immediately  turned  into  cash. 
When  drawn  to  A  B  or  order,  a  cheque  has  to  be  indorsed, 
or  signed  on  the  back,  by  A  B  before  the  bank  drawn  on  will 
pay  it.  A  still  further  restriction  is  the  English  system  of 
crossing  cheques,  that  is  to  say,  of  drawing  two  lines  across 
the  face  of  the  cheque,  by  which  mark  it  is  shown  that  the 
cheque  is  not  to  be  paid  in  cash  across  the  counter  by  the 
bank  drawn  on,  but  must  be  paid  into  a  bank  by  the  payee, 
and  so  only  becomes  credited  to  him  in  his  own  banking  ac- 
count through  the  operations  of  the  clearing  house.  It  is  evi- 
dent that  this  protection  greatly  increases  the  safety  of  the 
cheque,  since  if  it  fell  into  the  wrong  hands  its  chance  of 
being  made  fraudulent  use  of  is  greatly  diminished.  As  the 
lines  drawn  across  the  face  of  the  check  by  the  bankers'  cus- 
tomers are  often  faint  and  irregular,  it  has  been  found  in 
practice  that  they  lend  themselves  to  the  ingenuity  of  the 
fraudulent,  who  are  easily  enabled  to  erase  them  and  so  obtain 
possession  of  money  that  is  not  meant  for  them.  Some  of  the 
banks  therefore  print  these  crossing  lines  on  all  of  the  cheques 
that  they  issue  to  their  customers  to  be  filled  in,  and  when  the 


THE  JOINT  STOCK  BANKS  457 

customer  wishes  to  obtain  cash  from  his  bank  on  one  of  these 
cheques  he  is  consequently  obliged  to  write  upon  it  "  Please 
pay  cash,"  and  sign  this  note  upon  it.  The  extensive  use  of 
crossed  cheques  thus  tends  to  make  the  cheque  still  further  an 
instrument  which  merely  transfers  banking  credits  from  the 
books  of  one  bank  to  another,  since  every  crossed  cheque 
implies  that  it  can  not  be  turned  into  cash  directly,  but  can  only 
transfer  credit  with  one  bank  to  credit  with  another.  Another 
restriction  with  which  custom  has  protected  the  English  cheque 
is  the  system  of  writing  "  Not  negotiable  "  on  the  face  of  it. 
These  words  do  not  mean  that  the  cheque  is  really  not  negoti- 
able, but  their  legal  effect  is  that  the  holder  of  the  cheque  can 
not  establish  a  better  right  to  it  than  the  party  from  whom  he 
received  it.  If  therefore  the  party  from  whom  he  received  it 
had  no  right  to  it,  his  claim  against  the  paying  bank  is  nil. 
With  these  safeguards,  and  with  the  enormous  convenience  of 
being  drawn  to  any  amount  to  fit  the  exact  requirements  of 
each  transaction,  the  cheque,  although  not  legal  tender,  has 
been  enabled  to  supersede  the  bank  note  in  English  currency. 

The  chief  function  of  the  joint  stock  banks  having  thus  been 
shown  to  be  the  provision  of  currency  for  the  English  com- 
munity, it  may  further  be  noted  that  a  remarkable  development 
of  their  activity  has  been  the  rapidity  with  which  they  have 
covered  England  with  branch  establishments.  It  was  esti- 
mated in  1858  that  the  total  number  of  bank  offices  in  the 
whole  of  the  United  Kingdom  was  just  over  2,000;  at  the 
present  moment  the  aggregate  branch  offices  of  four  of  the 
English  joint  stock  banks  which  are  richest  in  respect  of 
branch  establishments  have  exceeded  this  total.  One  bank  in 
England  has  over  600  offices,  one  has  over  550,  two  have  over 
400,  three  have  more  than  200,  twelve  have  more  than  TOO. 
This  multiplication  of  branch  offices  has  been  carried  out 
partly  by  the  absorption  by  the  joint-stock  banks  of  the  smaller 
institutions  in  the  country,  whether  private  or  joint  stock,  and 
partly  by  the  rapidity  with  which  they  have  opened  branches 
in  the  great  provincial  centres  and  their  suburbs,  and  to  a 
moderate  extent  in  the  small  country  towns.  The  result  of  it 
is  to  give  the  English  monetary  system  the  power  of  easily 
supplying  the  needs  of  the  various  parts  of  the  community 


458  THE  ENGLISH  BANKING  SYSTEM 

as  the  requirements  of  others  ebb  and  flow.  At  the  same  time 
this  rapid  development  increases  the  competition  between  the 
various  English  banks,  which  we  have  already  shown  to  be 
carried  to  an  almost  excessive  degree,  and  by  the  wide  local 
distribution  of  their  liabilities  enhances  the  possibility  of 
strain  on  them  in  times  of  difficulty. 

Some  of  the  banks  include  under  the  heading  "  cash  at 
call  and  short  notice  "  advances  which  they  make  to  the  Stock 
Exchange  for  the  fortnightly  periods  that  elapse  between  its 
settlements.  The  funds  that  they  so  use  obviously  have  an 
important  effect  upon  the  marketability  and  price  of  securities 
in  London.  On  the  first  day  of  every  settlement  it  is  usual 
to  see  rates  quoted  as  those  at  which  the  banks  are  lending  to 
their  stock  exchange  clients  for  the  financing  of  speculative 
commitments.  In  the  arrangement  of  these  rates  a  certain 
amount  of  combination  and  co-operation  among  the  banks, 
or  some  of  them,  has  grown  up  as  a  matter  of  custom,  but 
since  for  this  class  of  accommodation  the  bankers  are  subject 
to  competition  on  the  part  of  the  agencies  of  the  foreign  banks 
and  the  big  finance  houses  it  is  often  found  difficult  to  main- 
tain even  this  amount  of  harmonious  working  among  the 
bankers. 

It  has  been  shown  that  the  rate  at  which  the  banks  make 
advances  to  the  discount  houses  has  an  important  effect  upon 
the  market  rate  of  discount  in  London,  but  the  banks  exercise 
a  still  more  important  and  direct  effect  upon  this  discount  by 
being  themselves  large  buyers  of  bills.  It  is  impossible  to 
gauge  exactly  the  extent  to  which  they  hold  bills  among  their 
assets,  since  many  of  them  in  their  balance  sheets  include  their 
discounts  along  with  their  loans  and  advances.  Among  the 
many  suggestions  that  reformers  have  put  forward  in  the 
matter  of  English  banking,  one  is  that  this  item  of  the  banks' 
holding  of  bills  should  be  separately  stated.  But  though  this 
obscurity  in  the  statements  of  the  English  banks  makes  it  im- 
possible to  know  the  precise  extent  to  which  they  hold  bills, 
there  is  no  doubt  their  purchases  of  them  are  on  the  whole 
the  most  important  influence  upon  the  market  rate  of  discount 
in  London.  Nearly  all  the  discount  houses,  whose  functions 
will  be  described  later,  buy  bills,  largely  with  the  intention  of 


THE  JOINT  STOCK  BANKS  459 

reselling  them  to  customers,  among  whom  the  joint-stock 
banks  are  the  largest  and  most  important  and  most  regular 
buyers,  and  it  is  contended  by  the  discount  houses  that  the 
market  rate  of  discount,  for  which  they  themselves  are  gen- 
erally supposed  to  be  responsible,  is  really  and  in  fact  regu- 
lated by  the  price  at  which  the  big  joint-stock  banks  are  pre- 
pared to  buy.  This  being  so,  since  the  market  rate  of  dis- 
count is  perhaps  the  most  important  influence  on  the  foreign 
exchanges  and  so  on  the  inward  and  outward  movements  of 
gold,  it  will  be  seen  that  this  function  of  the  bankers  is  one 
of  the  greatest  possible  importance  from  the  point  of  view  of 
London's  free  market  in  gold. 

Besides  thus  regulating  the  price  at  which  bills  of  exchange 
can  be  discounted  in  London,  the  banks  have  in  recent  years 
taken  an  increasingly  large  and  important  part  in  the  creation 
of  bills  of  exchange  by  placing  their  acceptances  at  the  disposal 
of  their  customers.  The  increasing  extent  to  which  the  bank- 
ers have  in  recent  years  intruded  into  this  class  of  business  is 
a  grievance  that  is  resented  rather  keenly  by  the  merchant 
firms,  or  accepting  houses,  as  they  are  often  called.  It  is 
contended  by  the  latter  that  the  business  of  acceptance  is  a 
special  function  for  which  special  training  is  required,  and 
that  the  joint-stock  banks  rarely  have  available  the  special 
abilities  that  make  for  its  proper  conduct.  On  the  other  hand, 
the  high  standing  of  the  joint-stock  banks  and  their  big  re- 
serve resource  in  the  shape  of  their  uncalled  capital  makes 
their  acceptances  an  exceptionally  fine  credit  instrument,  and 
it  seems  natural  enough  that  they  should,  to  a  certain  extent 
and  within  moderate  limits,  place  these  facilities  at  the  service 
of  their  customers. 

Finally  it  may  be  added  that  the  English  joint-stock  banks 
are  now  showing  a  disposition  to  engage  to  some  extent  in 
the  business  of  dealing  in  foreign  exchange  which  has  hitherto 
been  left  to  the  finance  houses  and  foreign  firms  established 
in  London.  The  London  and  County  and  the  London  City 
and  Midland  banks  have  now  established  regular  foreign  ex- 
change departments.  This  development  is  generally  welcomed 
as  a  sign  of  a  desire  on  the  part  of  the  banks  to  widen  their 
horizon  and  to  come  into  closer  touch  with  the  affairs  of  the 


460  THE  ENGLISH  BANKING  SYSTEM 

financial  world  at  large,  but,  as  in  the  case  of  the  banks'  in- 
creasing interest  in  acceptance,  there  are  some  critics  who 
consider  that  it  is  better  for  the  bankers  to  stick  to  their 
obvious  and  highly  important  function  of  providing  the  com- 
munity with  credit  and  currency,  and  taking  care  of  the  money 
of  their  customers. 


THE  PRIVATE  BANKS 

Any  differences  that  exist  between  the  prvate  and  joint-stock 
banks  of  England  lie  in  their  ownership  rather  than  in  their 
functions.  Their  functions  are  the  same,  but  the  manner  in 
which  they  carry  them  out  is  perhaps  influenced  to  a  slight 
extent  by  the  fact,  which  really  distinguishes  them,  that  the 
private  banks  are  owned  by  a  few  partners  who  generally 
conduct  the  business  for  themselves  or  exert  more  or  less 
influence  on  it,  while  the  joint-stock  banks  are  managed  by 
salaried  directors  and  officials  on  behalf  of  a  large  body  of 
shareholders  formed  into  a  public  company,  the  shares  in 
which  can  as  a  rule  be  bought  and  sold  on  the  London  Stock 
Exchange. 

Since  private  enterprise  naturally  precedes  joint-stock  in- 
stitutions, it  goes  without  saying  that  the  private  banks  of 
England  were  the  pioneers  of  the  banking  business.  There 
are  still  in  existence  private  firms  which  were  founded  before 
the  Bank  of  England.  A  goldsmith  called  Child  was  doing 
business  of  a  banking  character  soon  after  1660,  and  Child's 
Bank  still  exists.  Hoare's  Bank  was  instituted  in  about  1680, 
fourteen  years  before  the  Bank  of  England  received  its  char- 
ter. Modern  developments  have  almost  driven  them  out  of 
the  field,  and  among  the  leading  banks  in  the  city  of  London 
only  two  are  left  which  can  still  be  called  private  in  the  old 
sense  of  the  word.  There  are  one  or  two  other  institutions 
which  are  on  the  borderland;  and  at  the  west  end  of  the  town 
several  old  firms,  including  Child's  and  Hoare's,  have  retained 
their  old  constitutions. 


ACCEPTING  HOUSES  461 

THE  MERCHANT  BANKERS  AND  ACCEPTING  HOUSES 

The  most  important  function  of  the  merchant  bankers  is  not 
that  of  banking,  but  of  accepting.  Banking,  in  the  strict  sense 
of  the  term,  they  do  not  engage  in  —  that  is-to  say,  they  are 
not  prepared  to  meet  claims  upon  them  by  an  immediate  pay- 
ment of  cash  or  legal  tender  over  the  counter,  but  by  payment 
of  a  cheque  on  one  of  the  banks  in  the  stricter  sense  of  the 
term.  The  function  of  the  London  accepting  houses,  though 
of  enormous  importance,  is  still  to  a  certain  extent  subordinate 
to  the  judgment  of  the  English  banks.  They  finally  decide 
whose  paper  is  most  readily  negotiable,  and,  in  times  when  the 
credit  machine  is  felt  to  be  somewhat  out  of  gear,  the  bankers 
occasionally  discriminate  against  the  paper  of  firms  which  they 
consider  to  have  been  giving  their  acceptance  too  freely.  In 
this  respect,  as  in  so  many  others,  the  Bank  of  England  re- 
mains the  final  arbiter,  since  the  paper  of  an  accepting  house 
which  is  questioned  by  the  other  banks  can  be  negotiated  at 
the  Bank  of  England  through  a  discount  house,  and  the  Bank 
of  England  has  before  now  intervened  with  effect  when  it 
considered  that  questions  raised  concerning  certain  accept- 
ances have  been  without  justification. 

This  business  of  acceptance  is  one  into  which  the  other 
banks  have  themselves  recently  intruded  with  considerable  ef- 
fect, accepting  bills  for  their  customers,  home  and  foreign, 
for  a  commission;  and  there  is  a  certain  apparent  anomaly  in 
the  position  which  makes  them  guardians  of  the  volume  of 
acceptance  created  by  the  private  firms  and  acceptors  them- 
selves on  a  steadily  increasing  scale.  Nevertheless,  this 
anomaly  has  little  or  no  untoward  effect  in  practice.  The 
bankers  are  naturally  extremely  cautious  in  raising  any  ques- 
tion as  to  the  security  of  general  credit  in  London,  and  they 
are  in  many  ways  closely  connected  with  the  private  accepting 
houses,  so  that  the  system,  which  appears  to  be  full  of  un- 
comfortable possibilities  on  paper,  works  easily  enough  in 
practice. 

Other  functions  of  the  merchant  firms  and  accepting  houses 
are  their  activity  in  general  finance  and  in  exchange  business. 


462  THE  ENGLISH  BANKING  SYSTEM 

Both  these  functions  arise  out  of  their  old  business  as  mer- 
chants, which  gave  them  close  connection  both  with  the  gov- 
ernments and  the  business  communities  of  foreign  countries. 

THE  DISCOUNT  HOUSES 

The  great  volume  and  diversity  of  the  bills  of  exchange 
which  come  into  the  London  market  to  be  melted  and  turned 
into  present  cash  before  their  date  of  maturity  has  caused  the 
existence  of  a  class  of  dealers  in  bills  (bill  brokers)  who 
specialise  in  handling  them  and  may  be  regarded  as  inter- 
mediaries between  the  holders  of  the  bills  —  that  is  to  say, 
originally,  the  drawers  of  them,  or  their  representatives,  or 
any  one  else  into  whose  hands  they  may  have  passed  them  on  — 
and  the  bankers,  who  are  the  ultimate  buyers  and.  hold  them  as 
investments  until  maturity.  It  is  the  business  of  the  discount 
houses  to  buy  these  bills  on  a  wholesale  scale,  using  for  this 
purpose  funds  largely  lent  them  by  the  banks,  and  to  meet  the 
requirements  of  the  bankers  with  regard  to  the  date  named 
and  quality  of  the  bill,  providing  them  out  of  the  store  that 
they  keep  constantly  replenished. 

We  have  also  seen  that  the  discount  houses  fulfill  a  very 
important  function  by  borrowing  funds  from  the  bankers  at 
call  and  short  notice.  These  funds  are  regarded  by  the  bank- 
ers, and  actually  described  in  their  balance  sheets,  as  cash, 
cash  at  call,  and  short  notice.  It  is  a  somewhat  elastic  ex- 
tension of  the  term  "  cash  "  to  apply  it  to  money  that  is  being 
lent  to  any  borrower,  even  of  the  highest  credit  and  against 
the  most  liquid  possible  collateral.  But  it  is  always  assumed 
by  the  bankers  that  these  funds  placed  in  the  discount  market 
can  be  called  in  readily  at  any  moment.  That  they  can  be 
called  in  is  practically  a  fact;  but  it  arises  chiefly  from  the 
ability  of  the  discount  houses  when  pressed  for  repayment  of 
these  loans  by  the  bankers  to  fill  the  gap  in  credit  by  an  appeal 
to  the  Bank  of  England  and  the  production  of  fresh  cash,  as 
it  is  called,  by  borrowing  from  it.  The  discount  houses  take 
security  to  the  Bank  of  England  and  raise  with  it  the  right  to 
draw  cheques.  These  cheques  they  pay  to  their  bankers, 
whose  cash  at  the  Bank  of  England,  which  we  have  already 


LONDON  DISCOUNT  HOUSES  463 

seen  to  be  regularly  used  as  a  part  of  the  basis  of  credit  in 
England,  is  thus  increased. 

Besides  the  money  that  they  habitually  borrow  for  short 
periods  from  bankers,  the  discount  houses  also  have  consider- 
able amounts  placed  on  deposit  with  them  by  other  lenders, 
some  of  which  they  employ,  especially  in  times  when  the 
volume  of  bills  is  comparatively  small,  by  loans  to  the  Stock 
Exchange  for  financing  the  speculative  commitments  of  the 
public,  and  by  holding  or  carrying  securities  of  a  reasonably 
liquid  character.  They  also  take  some  part  in  the  under- 
writing of  new  loans  and  in  the  general  financial  business  of 
the  London  market. 

1  It  is  impossible  to  exaggerate  the  importance  of  the  func- 
tions which  the  bill  brokers  discharge  in  the  London  money 
market.  They  are  only  about  twenty  in  number,  including 
three  joint  stock  companies.  One  or  two  of  the  brokers  work 
on  commission,  as  your  brokers  do,  but  the  majority  are  really 
dealers  in  bills.  That  is,  they  buy  or  discount,  and  sell,  or 
rediscount,  bills  of  exchange. 

Let  me  illustrate  their  method  of  working:  A  bank  in  New 
York  may  buy  $1,000,000  worth  of  sterling  bills  drawn  on 
England  and  send  them  forward  to  its  London  agent  to  be 
discounted  with  the  bill  broker.  The  bill  broker  will  discount 
these  bills  at,  say,  4  per  cent.  If  he  thinks  rates  are  likely  to 
fall,  he  will  hold  the  bills;  if  he  thinks  them  likely  to  rise,  he 
will  try  to  sell  the  bills  at  about  3^  per  cent,  or  3%  per  cent, 
discount,  thus  making  a  profit  on  the  transaction  of  l/4  per 
cent,  or  l/%  per  cent,  per  annum.  Similarly  he  may  discount 
large  parcels  of  bills  for  Eastern  and  South  American  banks. 
Many  of  these  bills  will  be  bills  drawn  on  and  accepted  by 
banks  and  finance  houses.  These  are  known  as  "  bank  bills." 
But  on  the  other  hand,  the  bill  brokers  are  free  buyers  of 
"  trade  bills."  The  trade  bill  in  England  arises  in  the  follow- 
ing way:  Trader  A  sells  goods  to  trader  B.  He  will  draw 
a  draft  on  trader  B  at,  say,  three  months  date.  Trader  B  will 

1  James  H.  Simpson,  Some  Leading  Features  of  the  London  Money  and 
Discount   Markets,   an   address   delivered   at  the   annual   banquet  of  UK 
bankers  of  the  city  of  New  York.  Jan.  19,  IQI4-     (In  Banking  and  Ct 
rency  at   Home  and  Abroad,  Distributed  with  the  Compliments  c 
National  City  Bank.) 


464  THE  ENGLISH  BANKING  SYSTEM 

accept  the  draft  and  return  it  to  trader  A,  who  will  discount  it 
with  his  banker  or  with  the  bill  broker.  The  rate  of  discount 
for  trade  bills  is  usually  l/2  per  cent,  per  annum  higher  than  the 
rate  for  bank  bills. 

The  essential  feature  of  almost  all  the  bills  on  the  market  is 
that  they  represent  a  commercial  transaction,  such  as  a  sale  of 
goods,  where  value  passes.  It  is  this  that  lends  them  their 
self-liquidating  quality;  for  they  are  usually  liquidated  by  the 
acceptor  out  of  the  proceeds  of  the  resale  of  the  goods  during 
the  currency  of  the  bill. 

The  bill  broker  not  only  employs  his  own  capital  in  buying 
bills,  but  also  money  which  he  borrows  from  the  banks  and 
others  at  call  or  at  short  notice.  Enormous  sums  are  em- 
ployed in  this  way. 

INTERVIEW  WITH  THE  GOVERNOR  AND  DIRECTORS  OF  THE 
BANK  OF  ENGLAND 

1  Q.  When  does  your  present  charter  expire  ? 

A.  The  bank's  exclusive  privileges  of  banking  continue  sub- 
ject to  one  year's  notice  and  to  repayment  by  the  Government 
of  the  debt  of  £11,015,100  and  of  all  other  public  debt  held 
by  the  bank  at  the  time. 

Q.  What  is  the  par  value  and  present  selling  price  of  your 
shares  ? 

A.  The  bank's  capital  is  in  the  form  of  stock,  f  100  of 
which  is  at  present  quoted  at  about  £267. 

Q.  How  many  stockholders  have  you? 

A.  There  are  at  present  over  10,000  accounts. 

Q.  Is  the  stock  fully  paid? 

A.  Yes. 

Q.  Have  your  shareholders  any  liabilities  in  addition  to  the 
ownership  of  shares? 

A.  Legal  opinion  is  to  the  effect  that  there  is  no  further 
liability  on  bank  stock. 

Q.  Is  there  any  limit  to  the  number  of  shares  which  may  be 

1  Adapted  from  Interviews  on  Banking  and  Currency  Systems  of  Eng- 
land, Scotland,  France,  Germany,  Switzerland,  and  Italy,  Publications  of 
the  National  Monetary  Commission,  Senate  Document  No.  492,  6ist  Con- 
gress, 2nd  Session,  pp.  7-29. 


INTERVIEW  ON  THE  BANK  OF  ENGLAND  465 

held  by  any  one  person,  and  is  your  approval  required  before 
a  transfer  of  your  stock  can  be  made? 

A.  There  is  no  limit  —  the  bank's  approval  is  not  required. 

Q.  Does  every  share  have  a  vote  at  shareholders'  meetings  ? 

A.  To  have  a  vote  a  proprietor  must  hold  £500  of  stock, 
but  no  matter  how  much  additional  stock  a  proprietor  may 
hold  he  can  not  have  more  than  one  vote. 

Q.  Is  there  any  custom  restricting  the  class  from  which  the 
directors  may  be  selected  ? 

A.  There  is  no  legal  restriction  as  to  the  class  from  which 
directors  may  be  selected,  except  that  they  must  be  "  natural- 
born  subjects  of  England,  or  naturalized,"  but  in  actual  prac- 
tice the  selection  is  confined  to  those  who  are,  or  have  been, 
members  of  mercantile  or  financial  houses,  excluding  bankers, 
brokers,  bill  discounters,  or  directors  of  other  banks  operating 
in  the  United  Kingdom. 

Q.  How  many  branches  have  you? 

A.  There  are  eleven  branches  —  two  in  London  and  nine 
in  the  provinces. 

Q.  Is  the  business  conducted  at  your  branches  of  the  same 
class  as  at  your  main  office  in  London  ? 

A.  Yes. 

Q.  Do  your  branches  have  business  relations  with  mer- 
chants, farmers,  and  all  classes  of  people  in  their  respective 
localities  ? 

A.  There  are  no  restrictions  of  any  kind  as  to  the  class  of 
people  with  whom  the  bank  has  business  relations. 

Q.  Is  the  Bank  of  England  a  member  of  the  London  Clear- 
ing House? 

A.  Yes ;  but  "  on  one  side  only,"  as  it  is  termed.  The  Bank 
of  England  presents,  through  the  clearing  house,  all  drafts 
drawn  on  clearing  bankers  paid  in  to  it  by  its  customers ;  but 
the  clearing  bankers  do  not  present,  through  the  clearing 
house,  drafts  on  the  Bank  of  England  paid  in  to  them  by  their 
customers.  Such  drafts  are  paid  direct  to  the  credit  of  their 
accounts  at  the  Bank  of  England. 

Q.  Do  you  at  any  time  allow  interest  on  special  deposits  ? 

A.  It  is  not  the  practice  of  the  bank  to  allow  interest  on 
any  deposit. 


466  THE  ENGLISH  BANKING  SYSTEM 

Q.  Can  you  state  approximately  the  average  length  of  time 
and  the  average  size  of  bills  discounted  by  you? 

A.  Time,  forty  to  fifty  days;  size,  probably  about  £1,000. 

Q.  What  is  the  distinction  between  what  are  known  as 
"prime  bills"  and  other  bills? 

A.  A  "  prime  "  bill  we  should  define  as  a  bill  accepted  by  a 
London  or  provincial  bank  in  first-class  credit  or  a  merchant 
or  merchant  banker  of  the  first  class  whose  business  it  is  to 
grant  credits. 

Q.  Do  you  discount  any  prime  bills  ? 

A.  Yes. 

Q.  Do  you  discount  to  any  considerable  amount  for  indi- 
viduals and  merchants? 

A.  The  bank  discounts  all  approved  bills  offered  to  it  by 
persons  or  firms  having  properly  constituted  accounts. 

Q.  Is  it  your  custom  to  employ  surplus  funds  in  purchase 
of  bills  from  discount  houses? 

A.  No. 

Q.  Do  you  rediscount  bills  for  the  joint  stock  or  other 
banks  ? 

A.  The  bank  is  always  prepared  to  rediscount  for  other 
banks  at  its  official  rate,  and  does  a  large  business  from  time 
to  time  with  the  colonial  and  foreign  exchange  banks  who  are 
from  the  nature  of  their  business  always  sellers  of  bills. 

Q.  Would  you  charge  a  merchant  house  having  a  good  ac- 
count with  you  the  bank  rate  or  the  market  rate  for  prime 
bills? 

A.  The  market  rate. 

Q.  To  what  extent  does  bank  rate  govern  your  discount  and 
loan  transactions  ? 

A.  The  rates  for  discount  and  loan  transactions  at  the 
bank  usually  approximate  more  or  less  closely  to  the  bank  rate. 

Q.  Do  you  at  times  discount  bills  for  parties  having  no  ac- 
count with  you. 

A.  No. 

Q.  Are  a  considerable  number  of  your  loans  on  call? 

A.  None. 

Q.  When  and  under  what  conditions  is  the  bank  rate 
changed  ? 


INTERVIEW  WITH  SIR  FELIX  SCHUSTER  467 

A.  The  bank  rate  is  raised  with  the  object  either  of  pre- 
venting gold  from  leaving  the  country,  and  lowered  when  it 
is  completely  out  of  touch  with  the  market  rate  and  circum- 
stances do  not  render  it  necessary  to  induce  the  import  of  gold. 

Q.  Does  the  bank  sometimes  borrow  money  in  the  open 
market  for  the  purpose  of  raising  the  market  rate? 

A.  Yes. 

Q.  Do  you  sometimes  sell  consols  for  the  same  purpose  ? 

A.  Yes;  on  rare  occasions. 

INTERVIEW  WITH  SIR  FELIX  SCHUSTER,  GOVERNOR  OF  THE 
UNION  OF  LONDON  AND  SMITH'S  BANK  LIMITED 

1  Q.  Your  bank  is  organised  under  the  General  Companies 
Acts  as  are  all  joint  stock  banks  in  England  ? 

A.  Yes. 

Q.  You  are  not  under  government  supervision  or  examina- 
tion? 

A.  No. 

Q.  The  authorised  par  of  your  stock  is  £100,  and  £15  los. 
have  been  paid  on  each  ? 

A.  Yes. 

Q.  Are  your  shares  held  by  individuals  and  corporations  ? 

A.  By  individuals,  not  by  corporations.  There  are  up- 
wards of  8,600  different  shareholders. 

Q.  In  the  transfer  of  shares,  do  you  require  the  name  of 
the  transferee  to  be  submitted  and  approved  before  the  trans- 
fer is  made? 

A.  Yes. 

Q.  That  of  course  is  in  order  to  insure  the  responsibility  of 
your  stockholder? 

A.  This  is  in  order  to  insure  the  responsibility  of  our  stock- 
holder, and  to  prevent  one  holder  from  securing  too  large  a 
holding.  Furthermore  we  give  no  single  proprietor  more  than 
20  votes,  however  large  his  holding  may  be.  Every  10  shares 
carry  one  vote,  so  the  holder  of  200  shares  has  a  maximum 
number  of  votes. 

Q.  Is  that  the  usual  custom  with  the  joint-stock  banks  of 
England  ? 

1  Ibid.,  pp.  34-55. 


468  THE  ENGLISH  BANKING  SYSTEM 

A.  I  am  afraid  I  cannot  answer  offhand.  I  suppose  it  is 
so  in  some  cases,  but  the  practice  varies. 

Q.  In  London  there  is  usually  a  difference  between  the  rates 
charged  on  loans  and  bills  in  favor  of  bills,  is  there  not? 

A.  Yes. 

Q.  Would  you  say  that  that  difference  is  perhaps  from  one- 
half  to  i  per  cent,  in  favor  of  the  bill  ? 

A.  It  depends  so  very  much  on  the  circumstances  of  the 
moment  that  it  is  very  difficult  to  generalise.  At  the  present 
moment  I  would  say  a  three  months'  bill  is  worth  i%,  and  a 
three  months'  loan  would  be  worth  perhaps  3^2. 

Q.  Were  most  of  your  branches  organised  by  you  or  were 
most  of  them  other  institutions  purchased  by  you? 

A.  Some  of  them  were  other  institutions ;  some  of  them 
were  organised  by  us;  most  of  them  were  those  old  banking 
firms  which  were  carried  on  as  private  businesses  and  have 
since  become  branches  of  our  bank. 

Q.  The  tendency  is  for  the  consolidation  of  banking  in 
Great  Britain,  is  it  not? 

A.  Yes. 

Q.  Very  strongly  in  that  direction? 

A.  Very  strongly  in  that  direction,  yes. 

Q.  As  a  matter  of  fact,  a  large  part  of  the  commercial  bank- 
ing in  England  is  done  by  about  a  dozen  institutions,  is  it  not  ? 

A.  In  Liverpool  and  Manchester  there  are  very  important 
local  banks.  However,  it  is  no  doubt  the  fact  that  four  or 
five  banks  do  about  half  the  banking  business. 

Q.  In  the  main  you  believe  that  the  banking  situation  is 
stronger  and  better  and  the  country  is  better  served  through 
the  system  of  branches  than  through  the  independent  banks? 

A.  I  am  quite  convinced  of  that,  if  only  for  one  reason, 
that  I  do  believe  the  indiscriminate  granting  of  credits  to  the 
individual  is  injurious  to  himself,  the  private  bankers  being  too 
much  in  the  habit  of  regarding  old  family  associations  and  not 
so  careful  as  the  joint-stock  company  would  be,  and  he  has 
accustomed  people  to  trade  on  the  credit  that  they  get  from 
the  banker.  I  do  not  think  that  is  banking  business.  The 
bank  ought  never  to  supply  the  trader  with  working  capital. 
I  think  it  is  bad  for  the  trader. 


INTERVIEW  WITH  SIR  FELIX  SCHUSTER  469 

Q.  Is  it  not  quite  essential  to  the  success  of  a  financial  in- 
stitution doing  a  commercial  business  to  become  a  member  of 
the  Clearing  House  if  it  is  to  meet  with  a  large  degree  of 
success  ? 

A.  No.  After  all,  there  are  only  seventeen  banks,  I  be- 
lieve, now  in  the  Clearing  House,  but  there  are  a  great  many 
other  institutions  who  are  not  members  of  the  Clearing  House 
and  who  do  not  suffer  from  that  fact.  Scotch  banks  with 
branches  here  who  do  a  large  banking  business  are  not  mem- 
bers of  the  Clearing  House.  There  are  all  the  colonial  banks 
with  head  offices  or  branches  in  London  and  other  large  in- 
stitutions; those  are  not  members  of  the  Clearing  House. 
There  are  Barings  and  Rothschilds;  they  are  not  members  of 
the  Clearing  House. 

Q.  Would  you  say  the  Bank  of  England  is  in  any  way  a 
competitor  of  the  other  banks  in  England? 

A.  Yes.  That  is  a  source  of  very  grave  complaint  by  the 
other  banks. 

Q.  The  Bank  of  England  do  not  pay  interest  on  any  ac- 
counts ? 

A.  No;  but  in  some  cases  they  act  as  intermediaries  for 
lending  money.  It  is  a  very  subtle  distinction. 

Q.  While  the  bank  rate  is  fixed  and  is  to-day,  say  2}^  per 
cent.,  is  it  not  a  fact  that  the  Bank  of  England  does  some 
business  for  its  customers  and  also  purchases  bills  for  their 
account  at  a  lower  rate  ? 

A.  That  is  so,  and  that  is  one  of  the  matters  of  complaint. 
By  fixing  the  rate  at  2>4  per  cent.,  or  3  per  cent.,  or  4  per 
cent.,  they  can  regulate  the  rate  we  fix  for  our  own  customers. 
We  regulate  our  deposit  rate  in  accordance  with  the  bank  rate. 
We  also  regulate  the  rate  we  charge  for  our  loans  in  accord- 
ance with  the  bank  rate,  and  we  are  bound  by  it  to  a  certain 
extent,  and  they  themselves  feel  at  liberty  to  depart  from  it. 

Q.  What  does  the  bank  rate  mean;  what  does  it  govern 

in  fact? 

A.  It  means  the  general  charge  to  the  trade  of  the  country, 
because  although  we  say  that  bills  in  the  market  are  discounted 
at  a  lower  rate  than  bank  rate,  yet  there  is  a  vast  number  of 
trade  bills  which  are  purely  governed  by  the  bank  rate. 


470  THE  ENGLISH  BANKING  SYSTEM 

Q.  We  found  both  in  Germany  and  in  France  the  question 
of  the  amount  of  reserves,  either  in  specie  or  in  bank,  was  re- 
garded as  of  little  importance  by  the  bankers.  They  depend 
on  the  Reichsbank  and  the  Bank  of  France  for  rediscount  in 
times  of  need. 

A.  Both  in  France  and  in  Germany  banks  are  much  more 
dependent  on  the  central  institution  than  we  are  here.  They 
lean  on  their  central  institution  to  a  very  great  extent;  for 
instance,  the  rediscounting  of  bills  and  borrowing  from  the 
central  institution  is,  I  believe,  quite  a  usual  occurrence. 
Here  it  is  an  occurrence  which  would  only  take  place  in  the 
last  resort.  As  far  as  I  am  aware  this  bank  has  never  as 
long  as  it  has  been  in  existence  had  one  penny  from  the  Bank 
of  England,  whether  by  way  of  advance  or  by  way  of  a  dis- 
counted bill/  We  do  not  rediscount  our  bills-  in  the  market 
either;  so  every  transaction  we  enter  into  we  have  to  see 
through  to  the  very  end. 

INTERVIEW  WITH  MR.  CHARLES  Gow,  GENERAL  MANAGER 
OF  THE  LONDON  JOINT  STOCK  BANK,  LIMITED 

1  Q.  Your  capital  stock  is  £100  authorised,  £15  paid? 

A.  Yes. 

Q.  Does  your  board  pass  upon  a  new  stockholder  ? 

A.  Yes.  " 

Q.  Who  really  conducts  the  business  of  the  bank? 

A.  The  managers,  who  are  appointed  by  the  directors; 
that  is  to  say,  myself  and  all  those  belonging  to  me. 

Q.  Are  most  of  your  acceptances  secured? 

A.  Every  one. 

Q.  How  are  they  secured,  generally  speaking? 

A.  They  are  secured  in  the  great  majority  of  cases  by  bills 
of  exchange,  by  first-class  securities  with  plenty  of  margin, 
even  by  cash  in  hand  to  a  moderate  extent,  and  to  a  very  small 
extent  by  bills  of  lading  for  produce  shipped.  That  is  a  very 
small  item. 

Q.  Can  you  state  the  reason  for  accepting  bills  instead  of 
furnishing  the  cash  ? 

1  Ibid.,  pp.  60-91. 


INTERVIEW  WITH  MR.  CHARLES  GOW  471 

A.  We  accept  those  bills  because  it  happens  to  be  the  custom 
of  the  particular  banks  to  draw  a  long  bill.  The  customer 
himself  who  buys  cotton  in  Bombay,  or  wherever  it  may  be, 
acts  according  to  the  custom  there  to  draw  a  bill  to  a  certain 
usance.  Now,  for  instance,  with  regard  to  an  inland  bill, 
we  would  not  give  credit  of  that  sort  to  a  man  in  London, 
but  wherever  there  is  a  regular  course  of  business  abroad  to 
draw  at  long  usance  we  comply  with  it. 

Q.  What  is  the  character  of  your  bills  discounted  ? 

A.  Those  are  all  marketable  bills,  trade  bills;  you  know 
what  they  are ;  they  are  between  the  manufacturer  and  the  man 
to  whom  he  sells. 

Q.  You  always  require  two  names? 

A.  Always. 

Q.  What  does  the  form  of  obligation  by  the  borrowers  upon 
collateral  take? 

A.  Just  the  same  form  as  your  promissory  note. 

Q.  You  have  branches,  have  you  not  ? 

A.  We  have  about  forty-odd  branches  all  in  London  and 
close  to  London. 

Q.  You  do  not  then  endeavor  to  acquire  a  country  busi- 
ness through  your  branches  ? 

A.  For  this  reason,  that  we  commenced  as  a  purely  London 
bank,  and  we  have  so  far  kept  to  that  original  determination 
of  not  launching  out  into  country  business,  because,  as  I  say, 
it  differs  from  the  ordinary  London  business.  Country  busi- 
ness is  not  quite  so  liquid,  and  can  not  be. 

Q.  If  you  had  an  account  of  a  man  running,  say,  a  hat 
store,  his  account  was  satisfactory  in  character  and  had  been 
carried  with  you  for  several  years,  and  he  wanted  to  stock 
up  on  hats,  there  would  be  no  way  in  which  he  could  go  to 
you  and  borrow  the  money  with  which  to  buy  those  goods 
unless  it  was  through  a  guarantor  ? 

A.  No.  He  would  go  then  to  the  wholesaler  from  whom 
he  would  buy  the  goods,  and  give  that  wholesaler  his  bill,  and 
that  bill  would  be  a  discountable  article,  and  that  is  how  the 
money  would  be  raised. 

Q.  Do  you  ever  allow  overdrafts,  as  they  do  in  Scot- 
land? 


472  THE  ENGLISH  BANKING  SYSTEM 

A.  They  are  not  unheard  of,  but  not  a  principle  of  our 
business.  Overdraft  is  a  principle  of  country  banking. 

Q.  My  observation  leads  me  to  believe  that  the  banking 
situation  in  London  is  practically  controlled  by  twelve  or  four- 
teen of  what  are  known  as  the  London  joint-stock  banks, 
through  their  offices  and  through  their  branches? 

A.  Yes;  I  think  that  is  right.  However,  there  are  still  in- 
dependent banks  in  the  country,  and  I  doubt  whether 
amalgamation  will  go  very  much  farther  than  it  has  gone. 
You  see,  these  amalgamated  banks  have  already  become  so 
large  that  they  begin  to  get  a  little  unwieldy.  Lloyds  Bank 
is  an  enormous  thing,  with  $350,000,000  of  current  and  de- 
posit accounts. 

Q.  Would  you  say  that  the  public  are  better  served  through 
these  branches  than  they  were  through  the  independent  banks  ? 

A.  Some  say  that  they  are  not  so  well  served,  that  accom- 
modations are  curtailed  now  as  compared  with  what  they 
used  to  be,  and  that  I  can  understand  to  some  extent,  because, 
working  a  very  large  concern  from  one  centre,  you  see,  fiats 
will  go  forth,  "  Cut  that  man's  credit  off,"  and  not  listen  to 
taking  a  large  view.  They  say,  "  I  have  enough  of  that  kind 
of  accommodation;  I  have  100  shipbuilders  or  shipowners;  I 
am  not  going  to  give  out  more  than  a  proportion  of  my  money 
into  that  particular  trade ;  therefore,  I  will  not  have  any  more," 
whereas  the  independent  banks  would  be  perhaps  a  little  more 
accommodating. 

Q.  If  I  were  to  go  to  you  to-day  with  a  ninety-day  trade 
bill,  the  acceptor  known  to  you  as  good,  and  also  with  a  loan 
secured  by  Pennsylvania  Railroad  bonds,  my  loan  to  mature 
in  ninety  days,  what  rate  would  you  charge  me  on  those 
separate  items? 

A.  The  bank  rate  to-day  is  2.^/2  per  cent.  You  are  a  good 
customer,  and  I  should  charge  you  2^2  per  cent,  for  discount- 
ing that  trade  bill,  and  I  might  charge  you  3  per  cent.,  or 
even  perhaps  3^  per  cent,  on  the  Pennsylvania  Railroad  col- 
lateral for  this  reason,  that  one  is  not  as  realisable  as  the 
other.  When  the  bill  becomes  due  it  has  to  be  paid,  or  I  give 
it  back  to  my  customer,  and  say  "  Give  me  the  money  for  that." 
I  can  not  quite  say  the  same  to  him  about  his  collateral. 


INTERVIEW  WITH  MR.  CHARLES  GOW  473 

Q.  What  per  cent,  of  earnings  on  your  capital  did  you 
show  last  year? 

A.  Roughly,  our  net  earnings  were  20  per  cent.     It  cost  us 
50  per  cent,  of  our  gross  earnings  to  run  the  business. 
Q.  What  taxes  do  you  have  to  pay  ? 

A.  WTe  pay  income  tax  on  all  our  earnings,  and  deduct  from 
our  gross  profits.  We  are  entitled  to  deduct,  roughly  speak- 
ing, our  expenses,  and  then  upon  the  remainder  we  have  to 
pay  the  income  tax,  or  whatever  it  is,  at  I  shilling  in  the 
pound,  for  instance,  now. 

Q.  Would  you  say  that  the  Bank  of  England  is  a  popular 
banking  institution  among  other  banks  in  England  ? 

A.  Yes,  I  should  say  so  decidedly.  Its  popularity  goes  to 
this  extent,  that  it  is  absolutely  indispensable  to  them.  Some 
of  them  may  grumble  at  this  proceeding  or  that  proceeding, 
but  they  have  one  and  all  to  own  that  the  Bank  of  England  is 
indispensable  to  them. 

Q.  As  a  matter  of  fact,  if  you  had  presented  to  the  Bank 
of  England  last  fall  some  bills  which  had  been  negotiated 
through  you  which  appeared  to  be  finance  bills,  do  you  not 
think  they  might  have  gently  hinted  that  it  was  not  agreeable 
to  them  to  have  you  negotiate  any  more  finance  bills  ? 

A.  I  may  say  they  have  that  recourse,  and  they  might  say 
to  me  if  I  gave  them  any  just  cause  for  doing  it,  just  the 
same  as  anybody  else. 

Q.  In  other  words,  the  Bank  of  England  has  such  a  com- 
manding position  here  among  the  financial  institutions  which 
control  all  the  finances  of  Great  Britain  that  they  dominate 
it  when  they  choose  to? 

A.  When  they  choose. 

Q.  It  is  the  custom  of  the  bank  to  co-operate  very  cor- 
dially with  the  other  banks,  is  it  not? 

A.  Oh,  yes ;  we  are  as  free  as  free  can  be.  There  is  very 
little  conference,  or  anything  of  the  kind;  we  are  all  pretty 
good  friends  all  round. 


CHAPTER  XXIII 
THE  SCOTCH  BANKS 

1  THE  functions  performed  by  the  eight  Scotch  banks  and 
their  1,245  branches  2  are  essentially  similar  to  those  already 
described  as  being  carried  out  by  their  English  brethren.  The 
differences  between  the  currency  systems  of  the  two  countries 
are  in  degree  rather  than  in  essence.  In  Scotland  the  note 
issue  has  made  a  harder  fight  for  its  existence  than  in  Eng- 
land, owing  no  doubt  to  the  fact  that  the  Bank-  of  England's 
monopoly  did  not  extend  to  Scotland  and  that  the  great  Scotch 
joint-stock  banks  therefore  extended  the  system  of  using  notes 
as  currency,  while  the  development  of  joint-stock  banking  in 
England  was  necessarily  opposed  to  it,  since  joint-stock  banks 
in  England  with  an  office  in  London  were  unable  to  issue  notes. 
Nevertheless,  even  in  Scotland  the  advantages  of  the  cheque 
have  told  in  its  favour,  and,  as  will  be  seen  below,  liabilities  of 
Scotch  banks  under  note  issue  are  now  much  smaller  than 
those  under  deposit  as  current  accounts. 

DEMOCRACY  OF  SCOTCH  BANKING 

The  Scotch  note  circulation  increased  from  £5,332,000  in 
1872  to  £7,173,000  in  1908.  This  increase,  when  compared 
with  the  fact  that  the  note  issues  of  the  English  country  banks 
have  during  the  same  period  diminished  almost  to  vanishing 
point,  shows  that  the  bank  note  is  much  more  tenacious  of  life 
north  of  the  Tweed.  This  is  partly  owing  to  the  fact  that  in 
Scotland  notes  may  be  issued  of  the  denomination  of  £i, 
whereas  in  England  the  smallest  allowed  is  of  £5,  so  that  the 
note  was  thus  circulated  more  easily  among  the  poorer  classes 

1  Adapted  from  Hartley  Withers,  The  English  Banking  System.  Publi- 
cation of  The  National  Monetary  Commission,  Senate  Document  No.  492, 
6ist  Congress,  2nd  Session,  pp.  41-50. 

2  (September,  1915). 

474 


NOTES  AS  "  TILL  MONEY  "  475 

in  Scotland  and  so  gained  and  retained  a  hold  upon  a  much 
wider  circle  of  the  community.  In  this  respect,  as  in  others, 
Scotch  banking  is  more  democratic  than  English,  and  provides 
its  facilities  for  a  poorer  and  lower  class  of  the  community, 
though  this  distinction  between  the  banking  systems  of  the 
two  countries  is  being  rapidly  diminished.  Especially  in  its 
early  days  it  laid  itself  out  much  more  readily  to  the  en- 
couragement of  the  small  capitalist  and  borrower,  often 
granting  him  facilities  against  security,  or  an  absence  of  se- 
curity, which  would  have  been  only  regarded  as  feasible  under 
quite  exceptional  circumstances  in  England.  A  very  inter- 
esting system  was  at  one  time  fairly  general  in  Scotland,  and 
is  even  now  by  no  means  obsolete.  It  was  the  system  de- 
scribed as  that  of  cash  credits,  by  which  borrowers  were  able 
to  go  to  banks  and  obtain  advances  against  the  joint  personal 
security  of  themselves  and  one,  or  two,  or  three  friends.  By 
this  means,  in  which  a  kind  of  co-operative  responsibility  was 
recognised  as  a  security  by  the  Scotch  bankers,  very  poor  bor- 
rowers were  enabled  to  obtain  banking  facilities,  and  many 
instances  are  recorded  in  which  by  a  loan  of  this  kind,  of  quite 
small  importance  from  the  banking  point  of  view,  founda- 
tions of  fortunes  have  been  laid  and  the  general  commercial 
prosperity  of  the  community  has  been  furthered  in  a  very  satis- 
factory manner.  And  even  now  the  essential  difference  be- 
tween Scotch  and  English  banking  is  this  readiness  of  the 
former  to  take  into  consideration  the  personal  standing  of  the 
applicant  rather  than  the  stuff  or  paper  which  he  brings  to  it 
as  security  for  an  advance. 

USE  OF  NOTES  AS  "  TILL  MONEY  "  IN  RELATION  TO  THE 
ESTABLISHMENT  OF  BRANCHES 

Banking  by  branches  in  Scotland  has  proceeded  even  more 
rapidly  than  in  England,  and  the  percentage  of  branches  per 
head  of  the  population  is  higher  in  the  northern  part  of  the 
Kingdom.  This  wide  diffusion  of  banking  facilites  in  Scot- 
land has  been  largely  brought  about  by  the  fact  that  its  banks, 
having  the  privilege  of  note  issue,  were  able  to  hold  their  own 
notes  as  "  till  money,"  so  economising  in  the  matter  of  cash. 


476  THE  SCOTCH  BANKS 

The  following  passage  is  from  a  work  entitled  Scottish  Bank- 
ing, 1865-1896,  by  A.  W.  Kerr,  author  of  a  History  of  Bank- 
ing in  Scotland: 

Were  it  not  for  the  power  to  issue  notes,  and  the  readiness  with 
which  the  public  receive  them,  the  banks  could  never  have  af- 
forded to  open  a  third  of  the  branches  which  have  been  established. 
The  reason  for  this  is  a  very  simple  one.  Without  the  right  of 
issue  a  bank  must,  at  every  one  of  its  offices,  hold  the  whole  of  its 
balance  of  cash  in  the  shape  of  coin,  or  of  notes  of  other  banks, 
which,  as  far  as  it  is  concerned,  are  as  unprofitable  as  coin.  Such 
balances  entail  a  complete  loss  of  interest  which  can  only  be  borne 
where  the  amount  of  business  is  of  considerable  extent.  There  are 
probably  not  above  100  (at  most  200)  localities  in  Scotland  that 
would  satisfy  such  conditions.  When,  however,  a  bank  can  hold 
its  till  money  in  the  shape  of  notes,  it  is  enabled  to  extend  its 
operations  into  districts  which  would  otherwise  be  quite  inac- 
cessible. .  .  . 

The  authority  of  a  practical  Scotch  banker  is  equally  em- 
phatic on  the  point.  Mr.  Robert  Blyth,  general  manager  of 
the  Union  Bank  of  Scotland,  read  a  paper  at  the  thirty-first 
annual  convention  of  the  American  Banking  Association,  in 
October,  1905,  on  the  subject  of  Scottish  banking.  In  the 
course  of  this  very  interesting  paper  he  made  the  following 
statement :  "  It  is  in  another  quarter  altogether  that  the  Scotch 
banks  find  the  value  of  the  £i  note.  It  is  the  unissued  notes 
in  the  tills  of  the  branch  offices,  forming  the  till  money  at 
more  than  a  thousand  branches,  wherein  the  real  value  lies. 
Without  them  the  banks  would  require  to  keep  £8,000,000  01 
£10,000,000  of  gold  coin,  not  as  a  reserve  but  as  till  money. 
It  is  these  £i  notes  which  have  enabled  branch  offices  to  be 
planted  in  every  part  of  the  country." 

It  thus  appears,  from  the  highest  possible  authority,  that 
the  Scotch  banks  are  enabled  by  their  right  of  note  issue  to 
economise  gold  to  the  extent  of  £8,000,000  or  £10,000,000, 
and  it  is  amusing  to  observe  how  the  objects  aimed  at  by  Peel's 
legislation  with  regard  to  note  issue  have  thus  been  defeated 
even  more  completely  in  Scotland  than  in  England.  In  Eng- 
land banking  turned  the  flank  of  Peel's  Act  by  developing  the 
use  of  cheques,  which  superseded  the  note  as  the  common  form 
of  payment  in  daily  transactions.  In  Scotland,  banking 


EVASION  OF  PEEL'S  ACT  477 

evaded  the  spirit  of  Peel's  regulations,  which  were  intended  to 
insure  that  every  addition  to  currency  should  be  secured  on  an 
addition  to  the  bullion  held  by  it,  by  actually  economising 
bullion  to  the  extent  of  £8,000,000  or  £10,000,000. 


EVASION  OF  PEEL'S  ACT 

Scotland  used  the  same  weapons  as  England,  namely,  the 
cheque  and  the  development  of  deposit  banking.  The  eight 
Scotch  banks  have,  according  to  their  latest  balance  sheets, 
£7,000,000  of  notes  outstanding,  and  £108,000,000  of  liability 
on  deposits  and  drafts.  With  regard  to  the  latter  item  Peel's 
regulations  had  nothing  to  say,  and  since  ordinary  banking 
prudence  demanded  that  some  cash  should  be  held  against  it, 
and  since  the  gold  held  against  notes  was  not  specially  ear- 
marked as  such,  Scotch  banking  was  able  to  treat  its  cash 
against  deposits  as  the  basis  both  of  its  notes  and  deposits 
and  so  produce  the  economy  which  is  boasted  of  by  its  cham- 
pions. The  law  says  nothing  concerning  cash  to  be  held 
against  deposits,  and  the  metallic  basis  of  these  is  probably 
extremely  slender,  if  the  cash  held  against  notes  is  set  on  one 
side ;  but  it  is  impossible  to  detect  its  actual  amount,  since  the 
Scotch  banks  include  with  their  cash  their  balances  at  the  Bank 
of  England,  etc.  And  the  net  result  is,  that  when  the  propor- 
tion of  its  cash  to  its  total  liabilities  on  notes  and  deposits  is 
worked  out  it  is  found  to  be  decidedly  low,  even  when  com- 
pared with  English  practice.  For  the  eight  banks  taken  to- 
gether, gold  and  silver  coin,  notes  of  other  banks,  cash  at  Bank 
of  England,  and  cheques  in  course  of  transmission  represent 
almost  exactly  10  per  cent,  of  their  note  and  deposit  liabilities. 

It  should  be  observed  that  the  notes  which  the  Scotch  banks 
hold  as  till  money  do  not  appear  in  their  statements,  for  until 
they  are  issued  they  are  not  a  liability,  and  though  they  are 
treated  by  the  banks  in  practice  as  an  asset,  they  can  not  figure 
as  such  in  a  balance  sheet.  That  they  are  practically  treated  as 
such  is  witnessed  by  Mr.  Blyth,  as  quoted  above,  when  he  says 
that  without  them  the  banks  would  require  to  keep  £8,000,000 
or  £10,000,000  of  gold  coin.  And  it  is,  of  course,  this  habit 
of  regarding  unissued  notes  as  a  banking  asset  in  the  shape  of 


478  THE  SCOTCH  BANKS 

till  money  that  accounts  for  the  low  reserve  of  actual  cash  that 
the  Scotch  banks  show. 

DEFECTS 

Scotch  banking  is  so  generally  regarded  as  one  of  the  high- 
est achievements  of  the  banking  intelligence  that  some  hesita- 
tion is  natural  in  criticising  the  system  by  which,  according  to 
its  own  evidence,  it  has  obtained  most  of  its  success.  At  the 
same  time,  it  is  difficult  to  avoid  the  conclusion  that  a  serious 
danger  lurks  in  a  system  which  regards  a  banker's  unissued 
promise  to  pay  in  the  light  of  a  banking  asset.  Mr.  Blyth 
points  out  that  these  unissued  notes  are  "  not  a  reserve  but  till 
money,"  but  the  distinction  between  till  money  and  reserve  is 
one  upon  which  it  is  possible  to  lay  too  much  stress.  In 
assessing  the  strength  of  a  bank  it  is  usual  to  compare  the 
amount  of  its  cash  in  hand,  as  a  whole,  with  the  amount  of 
its  liability  to  the  public  on  deposit  and  current  account,  etc., 
and  note  circulation  if  any.  The  cash  in  hand,  as  a  whole, 
consists  of  the  till  money  and  cash  reserve.  If  the  till  money 
consists  to  any  extent  of  the  bank's  own  promises  to  pay,  it 
follows  that  the  bank's  cash  reserve  as  a  whole  is  to  that  extent 
weakened,  for  it  need  not  be  said  that  in  case  of  serious 
trouble,  which  is  a  contingency  of  which  all  provident  bankers 
have  at  all  times  to  beware,  a  bank's  own  promises  to  pay 
would  be  of  little  service  to  it.  If  a  bank's  credit  were 
doubted,  these  promises  to  pay  would  not  be  available  for  it  in 
meeting  demands  upon  it.  At  such  periods  the  public  requires 
from  its  bankers  not  promises  to  pay  but  physical  gold.  In 
Scotland  the  confidence  of  the  public  in  its  bankers  is  so  great, 
and  the  readiness  with  which  it  circulates  their  promises  to 
pay  appears  to  be  so  ingrained  in  the  national  character,  that 
the  contingency  of  the  demand  of  the  public  for  gold  seems 
to  be  extremely  remote.  The  criticism  therefore  which  de- 
tects a  weak  point  in  this  asset  upon  which  Scotch  banking 
prides  itself  so  highly  may  be  said  to  be  merely  academic. 
Nevertheless,  when  we  examine  Scotch  banking  by  the  test  of 
figures,  we  find  that  it  does  actually  work,  as  indeed  would  be 
expected  from  the  statement  of  its  exponents,  on  a  cash  basis 
which  is  decidedly  narrow. 


DEFECTS  479 

Though  the  functions  that  they  perform  are  practically  the 
same  as  those  of  the  English  bankers,  Scotchmen  have  suc- 
ceeded in  avoiding  the  excessive  competition  in  carrying  them 
out  which  is  a  weakness  of  English  banking.  In  Scotland,  on 
the  other  hand,  cohesion  and  co-operation  among  the  banks  are 
carried  to  an  extreme  of  which  the  mercantile  community  fre- 
quently complains.  The  banks  are  few  and  stand  together 
like  a  close  corporation ;  they  agree  absolutely  and  arbitrarily 
among  themselves  as  to  the  rates  they  will  allow  to  depositors, 
the  rates  at  which  they  will  advance  or  discount,  and  the  terms 
and  commissions  for  which  they  will  do  business  for  custom- 
ers. The  extent  to  which  this  regulation  of  the  price  of  the 
product  that  they  turn  out  is  carried,  is  almost  incredible  from 
the  English  point  of  view,  and  though  it  is  contended  by  the 
champions  of  the  Scotch  system  that  it  encourages  that  whole- 
some democratic  influence  in  Scotch  banking  which  is  in  favor 
of  the  small  borrower  of  limited  resources,  who  is  thus  able 
to  obtain  accommodation  on  the  same  terms  as  much  larger 
and  more  important  customers,  yet  it  must  be  obvious  that  the 
Scotch  banks,  by  making  these  hard  and  fast  agreements 
among  themselves  as  to  the  price  of  the  accommodation  that 
they  will  give,  and  maintaining  it  in  every  case,  are  in  fact 
putting  the  same  price  upon  a  very  different  article.  The  re- 
sult of  it  is  beginning  to  tell  upon  them  a  little  in  these  days, 
since,  when  the  big  Scotch  merchants  and  manufacturers  find 
that  their  local  bankers  charge  them  the  same  rates  for  ac- 
commodation as  the  small  tradesmen  of  the  towns,  they  are 
naturally  impelled  to  make  arrangements  to  provide  them- 
selves with  monetary  facilities  somewhere  south  of  the  Tweed, 
where  rates  are  ruled  by  the  circumstances  of  each  case,  and 
competition  and  higgling  often  in  times  of  monetary  ease  de- 
liver the  bankers  into  the  hands  of  the  borrowers.  As  it  is, 
the  Scotch  banks  in  regular  conclave  fix  their  rates  in  accord- 
ance with  those  current  in  the  London  money  market  or  the 
Bank  of  England's  official  minimum,  and,  having  fixed  them, 
stick  to  them.  The  system  is  very  profitable  to  themselves, 
and  their  customers  certainly  can  not  complain  on  the  whole 
of  the  facilities  with  which  they  provide  them.  Nevertheless, 
the  cast-iron  rigor  with  which  they  work  hand  in  hand  in 


480 

combination  appears  to  be  an  excessive  development  of  bank- 
ing unity,  and  an  ideal  banking  system  would  seem  to  lie  some- 
where in  the  middle  between  the  excessive  competition  of  the 
English  bankers  and  the  cast-iron  combination  of  their  Scotch 
brethren.  Finally,  it  may  be  added  that  it  is  a  little  inac- 
curate to  speak  of  a  Scotch  banking  system,  if  the  phrase  be 
taken  to  imply  that  Scotch  banking  stands  by  itself  and  works 
on  its  own  resources.  In  fact,  it  is  only  an  appendage  of  the 
English  system  and  relies  habitually  on  drawing  gold  from  the 
Bank  of  England,  as  its  centre  and  the  keeper  of  its  reserve. 

BANK  OF  SCOTLAND 
INTERVIEW  WITH  SIR  GEORGE  ANDERSON,  GENERAL  MANAGER  1 

Q.  When  was  the  Bank  of  Scotland  founded? 

A.  In  1695. 

Q.  When  does  your  present  charter  expire? 

A.  By  act  of  Parliament  the  "  governor  and  company  of 
the  Bank  of  Scotland  "  have  "  perpetual  succession." 

Q.  How  many  branches  have  you  ? 

A.  One  hundred  and  sixty-three  branches  and  twelve  sub- 
branches  in  Scotland ;  also  an  office  in  London. 

Q.  How  are  your  branches  managed? 

A.  By  agents  (managers  at  London  and  Glasgow)  ap- 
pointed by  the  directors. 

Q.  Do  your  branches  have  business  relations  with  mer- 
chants, farmers,  and  all  classes  of  people  in  their  respective 
localities  ? 

A.  Yes. 

Q.  What  is  the  law  governing  your  note  issues,  and  how 
are  note  issues  limited  and  how  secured? 

A.  The  bank  is  authorised  to  issue,  without  holding  coin 
against  them,  notes  to  the  value  of  £396,852,  but  for  any  ex- 
cess beyond  that  amount  we  must  hold,  at  the  head  office,  an 
equivalent  value  in  gold  coin,  one-fourth  of  which  may,  how- 
ever, be  in  silver  coin. 

1  Adapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 
England.  Scotland.  France,  Germany.  Switzerland  and  Italy,  Publications 
of  the  National  Monetary  Commission,  Senate  Document  No.  405,  6ist 
Congress,  2nd  Session,  pp.  142-155. 


ROYAL  BANK  OF  SCOTLAND  481 

Q.  Will  you  state  (a)  the  class  of  bills  usually  discounted 
by  you,  giving  the  number  of  names  required;  (b)  the  mini- 
mum size;  and  (c)  the  maximum  length  of  time  to  run? 

A.  Mercantile  bills,  also  a  few  accommodation  bills,  usually 
two  names;  minimum,  say,  £10.  The  maximum  length  of 
time  to  run  is  six  months. 

Q.  What  classes  of  collateral  are  accepted  by  you  for  loans? 

A.  Personal  security,  marketable  securities,  life  policies, 
mortgages  over  ships,  shipping  documents,  etc.  In  the  im- 
portant banking  centers  of  Scotland  lending  against  collateral 
security  has  become  largely  prevalent. 

Q.  Do  you  rediscount  bills  from  other  banks? 

A.  No. 

Q.  Explain  the  phrase  "  cash  credits,"  and  upon  what  con- 
ditions are  they  given? 

A.  A  "  cash  credit "  is  a  credit  allowed,  in  virtue  of  which 
a  customer  may  draw  cheques  on  the  bank  until  the  balance 
due  to  us  reaches  a  certain  fixed  limit.  The  account  is  an 
ordinary  operative  one,  and  interest  is  charged  on  the  balances 
actually  due  to  the  bank  from  day  to  day. 

Q.  Have  you  in  mind  how  many  branches  you  had  ten 
years  ago? 

A.  One  hundred  and  twenty. 

Q.  Do  you  ever  buy  any  shares  of  railroad  or  industrial 
companies  ? 

A.  Yes ;  of  the  highest  class. 

Q.  Do  you  ever  own  bank  shares  ? 

A.  No. 

ROYAL  BANK  OF  SCOTLAND 
INTERVIEW  WITH  ADAM  TAIT,  CASHIER  AND  GENERAL 

MANAGER  * 

Q.  When  was  the  Royal  Bank  of  Scotland  founded? 

A.  In  the  year  1727. 

Q.  When  does  your  present  charter  expire? 

A.  It  is  perpetual. 

Q.  How  many  branches  have  you? 

1  Ibid.,  pp.  127-139. 


482  THE  SCOTCH  BANKS 

A.  One  hundred  and  fifty-two. 

Q.  Are  all  your  branches  of  the  same  class,  or  have  you 
main  and  subsidiary  branches? 

A.  In  some  cases  there  are  sub-branches.  Some  are  mainly 
or  almost  entirely  deposit  branches ;  others  have  few  deposits, 
but  a  large  advance  business. 

Q.  Is  the  business  conducted  at  your  branches  of  the  same 
class  as  at  your  office  in  London  ? 

A.  No ;  the  London  office  is  itself  a  branch  office  and  much 
of  the  ultimate  settlement  of  balances  takes  place  there.  The 
conduct  of  the  ordinary  London  business  is  on  the  same  lines 
as  that  of  any  other  London  branch  bank.  No  notes  can  be 
issued  in  London. 

Q.  Do  your  branches  have  business  relations  with  mer- 
chants, farmers,  and  all  classes  of  people  in  their  respective 
localities  ? 

A.  Yes,  they  have  business  relations  with  all  classes  of 
people. 

Q.  What  is  the  law  governing  your  note  issues,  and  how 
are  note  issues  limited  and  how  secured? 

A.  The  act  of  Parliament  of  1845  governs  our  note  issue. 
There  is  no  limit  to  the  amount  of  notes  that  may  be  issued, 
but  the  bank  is  required  to  hold  gold  (and  silver  to  an  extent 
not  exceeding  one-fifth  of  the  total)  against  the  notes  in  the 
hands  of  the  public  on  the  average  of  each  month,  and  that  at 
its  head  office  in  Edinburgh  —  gold  held  at  branch  offices  does 
not  count  —  to  an  amount  sufficient  each  week  on  Saturday 
to  cover  the  notes  in  the  hands  of  the  public  in  excess  of  a 
certain  amount  specified,  £216,451. 

Q.  To  what  extent  are  your  notes  legal  tender  in  Great 
Britain? 

A.  Our  notes  are  not  legal  tender  at  all. 

Q.  What  other  banks  have  the  right  of  issue  in  Scotland? 

A.  The  Bank  of  Scotland,  the  British  Linen  Bank,  the  Com- 
mercial Bank  of  Scotland  (Limited),  the  National  Bank  of 
Scotland  (Limited),  the  North  of  Scotland  and  Town  and 
County  Bank  (Limited),  the  Union  Bank  of  Scotland  (Lim- 
ited), the  Clydesdale  Bank  (Limited). 


ROYAL  BANK  OF  SCOTLAND  483 

Q.  Are  the  notes  of  your  issuing  banks  secured;  and  if  so, 
how  ? 

A.  They  are  not  secured.  In  case  of  the  liquidation  of  the 
five  last-named  banks,  however,  their  shareholders  are  un- 
limitedly  liable  for  their  notes  and  they  are  liable  to  con- 
tribute a  sum  necessary  to  restore  to  the  general  assets  the 
sums  that  may  have  been  paid  out  of  the  same  in  respect  of 
claims  under  notes. 

Q.  What  is  the  total  amount  of  their  outstanding  issues? 

A.  About  £7,500,000. 

Q.  Do  you  pay  the  Government  in  the  form  of  taxes  or 
otherwise,  either  directly  or  indirectly,  for  your  privilege  of 
note  issue? 

A.  Yes,  we  all  pay  a  license  duty  of  £30  for  each  place  at 
which  notes  are  issued,  and  a  tax  of  8s.  ^d.  per  £100,  or  a 
penny  per  £i,  on  the  average  amount  of  notes  in  the  hands 
of  the  public  at  the  close  of  each  week. 

Q.  Is  it  your  custom  to  carry  a  fixed  amount  in  govern- 
ment securities? 

A.  Yes,  but  the  amount  is  not  rigidly  fixed. 

Q.  Do  you  discount  any  but  prime  bills? 

A.  Yes;  we  do  all  classes  of  business. 

Q.  Is  it  your  custom  to  employ  surplus  funds  in  purchase 
of  bills  from  discount  houses? 

A.  Yes ;  bills  accepted  by  London  banks. 

Q.  Do  you  rediscount  bills  for  other  banks? 

A.  No;  except  for  foreign  or  colonial  banks  who  are  cor- 
respondents. 

Q.  Is  the  bank,  through  its  branches,  employed  by  other 
banks  to  any  considerable  extent  for  the  transfer  of  funds 
from  one  city  to  another? 

A.  Yes. 

Q.  What,  if  any,  artificial  means  are  taken  by  you  to  secure 
changes  in  the  volume  of  currency  (notes  and  coin)  to  make 
it  responsive  to  business  demands? 

A.  None  are  deemed  necessary.  Our  system  works  auto- 
matically. Our  note  issue  is  unlimited ;  we  are  only  required 
to  provide  gold  to  cover  the  amount  in  the  hands  of  the  public 


484  THE  SCOTCH  BANKS 

at  the  close  of  each  week  and  on  the  average  of  each  four 
weeks. 

Q.  What  is  the  customary  charge  for  acceptance  of  a  ninety- 
day' bill? 

A.  Five  shillings  per  cent. 

Q.  Your  acceptance  constitutes  what  is  known  in  London  as 
a  prime  bill? 

A.  Yes. 

Q.  Do  you  pay  interest  on  both  current  accounts  and  de- 
posit accounts? 

A.  It  is  our  custom  to  pay  interest  on  deposits  only.  In 
London,  however,  it  is  different;  there  interest  is  allowed  in 
special  cases  on  large  balances  on  current  accounts  if  left  for 
some  time. 

Q.  How  does  the  bank  rate  affect  the  rate  allowed  by  you 
on  deposit? 

A.  The  Scotch  banks  all  allow  the  same  rate  and  charge 
the  same  rates  for  discounts  and  overdrafts,  and  these  are 
fixed  relatively  to  the  Bank  of  England  rate.  Our  deposit 
rate  is  usually  i  ^2  per  cent,  under  the  minimum  bank  rate. 

Q.  Were  most  of  your  branches  organised  by  you  or  were 
most  of  them  other  institutions  purchased  by  you? 

A.  Most  of  them  were  originated  by  ourselves. 

Q.  Have  you  in  mind  how  many  branches  you  had  ten 
years  ago? 

A.  About  136. 

Q.  What  relations  do  the  Scotch  banks  bear  to  the  Bank 
of  England?  Do  they  deal  with  it  directly? 

A.  The  Royal  Bank  of  Scotland  has  an  account  with  the 
Bank  of  England,  which  has  been  in  operation  since  1728,  and 
it  collects  bills  and  cheques  for  the  Bank  of  England  all  over 
Scotland. 

Q.  Do  you  regard  your  system  of  currency  issue  as  suffi- 
ciently elastic  for  your  needs? 

A.  Yes ;  there  never  has  been  any  difficulty.  Moreover,  no 
Scotch  bank  has  ever  failed  to  pay  its  creditors,  including  the 
holders  of  notes,  in  full. 


COMMERCIAL  BANK  OF  SCOTLAND  485 

COMMERCIAL  BANK  OF  SCOTLAND  (LIMITED) 
INTERVIEW  WITH  ALEXANDER  BOGIE,  GENERAL  MANAGER  1 

Q.  When  was  the  Commercial  Bank  of  Scotland  (Limited) 
founded  ? 

A.  In  the  year  1810. 

Q.  When  does  your  present  charter  expire  ? 

A.  It  is  not  limited  in  point  of  time. 

Q.  Has  the  Government  any  voice  in  the  management  of 
the  bank  or  any  interest  in  it  through  the  ownership  of  shares? 

A.  None. 

Q.  Have  the  managers  of  the  branches  full  control  of  the 
business  in  granting  discounts,  etc.;  if  not,  what  discretion  is 
usually  given  them? 

A.  Agents  have  power  to  grant  advances,  but  subject  to  the 
approval  of  head  office.  In  advances  of  considerable  amount, 
an  agent's  duty  is  to  get  authority  from  the  head  office  before 
granting  it.  The  discretion  allowed  is  dependent  on  the  size 
of  the  branch  and  the  nature  of  the  business  and  the  class  of 
customer,  and  on  the  record  of  the  agent.  By  our  system  of 
reports  on  advances  (weekly,  monthly,  and  quarterly)  we  keep 
in  close  touch  with  the  advances  and  means  of  borrowers. 
The  London  branch  is,  of  course,  on  different  lines,  and  our 
manager  there  has  greater  powers  than  an  agent  at  a  branch 
in  Scotland. 

Q.  Is  the  business  conducted  at  your  branches  of  the  same 
class  as  at  your  main  office  in  Edinburgh  ? 

A.  Yes;  very  much  the  same.  The  head  office  has  ad- 
ministrative work  and  supervision  of  branches,  investment, 
etc.,  which  does  not,  of  course,  arise  elsewhere. 

Q.  Do  you  discount  to  any  considerable  amount  for  indi- 
viduals and  merchants? 

A.  Yes ;  it  would  perhaps  be  well  to  point  out  that  in  Scot- 
land a  large  portion  of  advances  made  to  traders  are  granted 
in  the  form  of  overdrafts  on  current  accounts.  The  number 
and  amount  of  bills  in  Scotland  are  less  noiv  than  in  former 
years.  Cash  payments  for  the  purpose  of  obtaining  discount 

1  Ibid.,  pp.  172-185. 


486  THE  SCOTCH  BANKS 

are  more  frequent,  and  the  number  of  bills  discounted  by 
wholesale  houses  is  reduced  in  consequence. 

Q.  Is  it  your  custom  to  employ  surplus  funds  in  purchase  of 
bills  from  discount  houses? 

A.  Only  occasionally,  when  rates  suit. 

Q.  Do  you  rediscount  bills  for  other  banks? 

A.  It  is  not  our  practice  to  do  so. 

Q.  To  what  extent  does  bank  rate  govern  your  discount  and 
loan  transactions? 

A.  In  ordinary  transactions,  altogether.  In  all  transac- 
tions the  bank  rate  governs  as  regards  the  minimum. 

Q.  Explain  the  phrase  "  cash  credits,"  and  upon  what  con- 
ditions are  they  given  ? 

A.  A  cash  credit  account  is  an  operative  current  account  in 
security  of  which  the  principal  debtor  and  twro  .or  more  co- 
obligants  have  granted  a  personal  bond  in  favor  of  the  bank. 
The  account  is  operated  upon  by  the  principal  debtor,  but  all 
the  parties  are  bound  as  principals  and  are  jointly  and  severally 
liable  to  the  bank.1 

Q.  Is  the  bank,  through  its  branches,  employed  by  other 
banks  to  any  considerable  extent  for  the  transfer  of  funds 
from  one  city  to  another? 

A.  We  act  as  correspondents  for  the  large  English  and  Irish 
banks  and  for  colonial  and  foreign  banks. 

Q.  Do  you  favor  the  issue  of  £i  notes?     Why? 

A.  Yes;  tinder  the  Scottish  system,  as  it  enables  the  banks 
to  plant  branches  at  little  expense  and  so  to  open  up  the  trade 
of  the  country  in  all  districts  and  directions. 

Q.  It  is  your  practice  to  employ  your  surplus  funds  in  the 
purchase  of  prime  bills  through  bill  brokers? 

A.  We  occasionally  have  such  transactions. 

Q.  Were  most  of  your  branches  organised  by  you,  or  were 
most  of  them  other  institutions  purchased  by  you? 

A.  All  of  them  were  organised  by  ourselves. 

Q.  Is  the  question  of  the  amount  of  reserves,  either  in 
specie  or  in  bank,  regarded  as  of  importance  by  Scotch 
bankers  ? 

1  The  cash  credit  system,  sometimes  pointed  to  as  a  unique  feature  of 
Scotch  banking,  is  by  no  means  unknown  in  England. —  EDITOR. 


UNION  BANK  OF  SCOTLAND  487 

A.  I  should  think  so,  though  I  only  know  positively  my  own 
opinion. 

Q.  Do  you  ever  buy  any  shares  of  railroad  or  industrial 
companies  ? 

A.  No  industrial  company  shares  and  only  gilt-edged  rail- 
way stocks. 

Q.  Do  you  ever  own  bank  shares  ? 

A.  No. 

UNION  BANK  OF  SCOTLAND  (LIMITED) 
INTERVIEW  WITH  ROBERT  BLYTH,  GENERAL  MANAGER  1 

Q.  When  was  the  Union  Bank  of  Scotland  (Limited) 
founded  ? 

A.  In  1830. 

Q.  When  does  your  present  charter  expire? 

A.  The  bank  has  no  charter  expiring  at  any  specified  time. 
It  is  incorporated  under  the  companies  acts. 

Q.  Have  the  obligations  of  the  bank  to  the  public  or  to  the 
Government  been  changed  from  time  to  time  ? 

A.  The  liability  of  the  shareholders  was  formerly  unlimited, 
but  when  the  bank  became  registered  under  the  companies 
act,  1879,  the  liability  of  the  shareholders  —  unless  in  respect 
of  notes  —  was  limited  to  the  amount  of  the  uncalled  capital. 

Q.  The  tendency  is  for  the  consolidation  of  banking  in 
Great  Britain,  is  it  not  ? 

A.  It  is,  but  this  tendency  set  in  at  a  much  earlier  period 
in  Scotland  than  it  has  done  in  England. 

Q.  Do  you  rediscount  bills  for  other  banks? 

A.  Yes ;  but  only  to  a  very  limited  extent. 

Q.  Is  private  banking  carried  on  in  Scotland? 

A.  Private  banking  ceased  to  exist  in   Scotland  prior  to 

1845- 

Q.  Do  you  ever  buy  any  shares  of  railroad  or  industrial 

companies? 
A.  No. 

Q.  Do  you  ever  own  bank  shares  ? 
A.  No. 

1 1bid.,  pp.  157-170. 


CHAPTER  XXIV 
THE  FRENCH  BANKING  SYSTEM 

THE  BANK  OF  FRANCE 

1  THE  Bank  of  France  was  established  in  the  year  1800, 
and  was  at  first  an  entirely  private  concern,  with  a  capital  of 
$6,000,000.  Among  the  first  subscribers  were  Napoleon 
Bonaparte,  Hortense  Beauharnais,  and  bearers  of  names  which 
are  still  prominent  in  the  French  banking  world,  such  as 
Mallet,  Hottinguer,  Seillers,  etc. 

At  that  time,  the  privilege  of  issuing  notes  was  not  confined 
to  a  single  bank.  But  in  1806  the  Bank  of  France  was  placed 
under  state  control,  and,  by  and  by,  the  other  issuing  banks 
disappeared,  by  amalgamation  or  otherwise,  and  the  Bank  of 
France  became,  and  has  ever  remained  since,  the  only  issuing 
bank  in  Continental  France. 

The  present  capital  is  $36,500,000,  all  paid,  divided  in  $200 
shares.  .  .  .  [Francs  are  given  in  terms  of  dollars.] 

These  shares  are  held  by  the  public,  the  average  being  about 
$l/2  shares  for  each  shareholder.  One-third  of  the  shares  are 
held  by  persons  possessing  only  one  share.  They  are  dealt 
in  freely  in  the  market,  their  quotation  being  at  present  about 
465  per  cent. 

The  profits  go  to  the  shareholders,  as  in  every  other  com- 
pany. In  1912  the  bank  earned  a  net  profit  of  $8,200,000. 
The  last  yearly  dividend  was  paid  at  the  rate  of  20.83  Per 
cent.  .  .  . 

The  governor  of  the  Bank  of  France  and  the  two  sub- 
governors  are  appointed  by  the  State.  They  are  assisted  by 
fifteen  regents,  nominated  by  the  meeting  of  the  shareholders. 
The  same  meeting  appoints  three  censors  whom  you  would  call 
auditors. 

1  M.  Robert  Masson,  Sous-Directeur  du  Credit  Lyonnais,  The  Bank  of 
Prance,  an  address  delivered  at  the  annual  banquet  of  the  bankers  of  the 
city  of  New  York,  January  19,  1914. 


THE  BANK  OF  FRANCE  489 

The  board,  composed  of  the  governors  and  regents,  decides 
all  questions  concerning  the  rate  of  discount  on  loans,  the  issue 
of  notes,  etc. 

Three  of  the  regents,  assisted  by  twelve  shareholders  chosen 
from  amongst  the  prominent  members  of  the  commercial  and 
industrial  profession,  compose  the  "  discount  committee," 
which  meets  at  least  three  times  a  week  and  decides  upon  the 
acceptance  or  refusal  of  the  bills  presented  for  discount.  .  .  . 

The  notes  are  .  .  .  legal  tender,  but,  of  course,  may  be 
exchanged,  at  sight,  against  cash  —  I  don't  say  against  gold, 
as  I  will  explain  presently. 

The  denominations  circulating  at  present  are  $10,  $20,  $100, 
and  $200.  One  dollar  and  $4  notes  were  issued  at  critical 
times,  but  have  been  withdrawn  since.  In  case  of  need,  they 
would  be  resorted  to  again,  and  in  this  respect  I  should  like  to 
mention  the  fact,  demonstrated  by  experience,  that  even 
where  the  circulation  is  already  sufficient,  a  supplementary  issue 
of  small  notes  —  unless,  of  course,  the  amount  be  too  unreas- 
onable —  is  much  less  likely  to  depreciate  the  currency  than 
an  issue  of  larger  ones.  In  a  certain  sense,  we  may  consider 
that  a  country  which  refrains  from  issuing  small  notes  in 
normal  times,  possesses  ipso  facto  a  valuable  reserve  in  case  of 
emergency.  .  .  . 

I  need  not  recall  the  remarkable  role  played  by  the  Bank  of 
France,  under  the  leadership  of  its  very  distinguished  gov- 
ernor, M.  Pallain,  during  critical  periods  such  as  1907,  when 
that  institution  succeeded  in  keeping  the  French  discount  rate 
on  an  exceptionally  moderate  level,  while  giving  valuable  and 
effective  aid,  at  the  same  time,  to  the  London  market. 

How  is  this  successful  policy  of  the  Bank  of  France  ma- 
terially possible?  Precisely  because  it  has  the  option  to  pay 
in  silver  as  well  as  in  gold.  When  the  situation  is  such  that 
withdrawals  of  yellow  metal  are  to  be  feared,  the  bank  quotes 
a  premium  on  gold.  At  present,  for  instance,  the  quotation 
is  about  one-tenth  of  one  per  cent,  premium,  that  is  to  say,  you 
will  only  get  $999  in  gold  against  $1,000  in  notes.  If  you 
want  to  get  $1,000  cash,  you  can  get  them,  but  in  silver. 

As  a  consequence,  there  is  no  necessity  to  raise  the  discount 
rate  in  order  to  protect  the  gold  reserve,  and  French  commerce 


490  THE  FRENCH  BANKING  SYSTEM 

has  the  privilege  of  benefiting,  as  a  rule,  by  the  lowest  rate  of 
discount  in  the  world.  Thus  the  average  bank  rate,  in  1912, 
was  3.37  per  cent,  in  France,  as  against  3.77  per  cent,  in 
England,  and  4.95  per  cent,  in  Germany. 

If  we  consider  a  period  of  fifteen  years,  from  1898  to  1912, 
the  average  rates  are : 

per  cent 

France  3.8 

Holland    3-52 

England    3.62 

Belgium 3.65 

Switzerland    4.14 

Austria    4.22 

Germany     4.50 

CASH    HOLDINGS   OF   THE   BANK   OF   FRANCE 

1  The  undeniable  characteristic  of  our  present  currency  sys- 
tem is  that  it  presents  a  transition  between  the  money  system 
and  the  clearing  system,  the  ultimate  form  of  which  we  are 
unable  accurately  to  define.  This  period  of  transition,  which 
began  when  the  idea  of  genuine  credit  was  conceived,  will  last 
for  centuries  before  we  can  rid  ourselves  of  money  as  a 
medium.  The  system  of  purely  fiduciary  currency,  which  is 
in  process  of  becoming  firmly  established,  is  not  yet  sufficiently 
stable  to  prevent  us  from  being  thrust  rudely  back  into  the  old 
ways  whenever  we  exceed  the  limits  of  our  resources. 

Crises  afford  a  striking  proof  of  this  fact.  The  initial 
period,  the  precursor  of  the  crisis,  is  nothing  but  an  abnormal 
extension  of  credit  and  of  speculation.  At  such  times  the 
need  of  leaning  upon  the  solid  foundation  of  metallic  currency 
is  felt  with  a  new  intensity ;  and  when,  with  a  blindness  result- 
ing from  overconfidence,  this  need  has  been  neglected,  when, 
from  a  disregard  of  the  functions  of  money,  a  crisis  is  brought 
about  by  the  violent  rupture  of  the  equilibrium  of  credit,  gold 
at  once  resumes  its  rights,  is  sought  for  on  all  sides,  and,  ac- 
cording to  the  seriousness  of  the  offence,  exacts  complete 
amends,  with  the  honors  of  a  premium  as  high  as  it  may 
choose  to  make. 

' l  Adapted  from  Maurice  Patron,  The  Bank  of  France  in  Its  Relation 
to  National  and  International  Credit,  Publications  of  the  National  Mone- 
tary Commission,  Senate  Document  No.  494,  6ist  Congress,  2d  Session. 


THE  BANK  OF  FRANCE  491 

It  clearly  appears,  therefore,  that  this  quest  for  simplifica- 
tion in  the  means  of  credit,  which  each  nation  ardently  pur- 
sues in  the  interest  of  its  own  industrial  and  commercial  de- 
velopment, demands  the  greatest  circumspection.  In  develop- 
ing credit,  metallic  currency  must  not  be  too  much  overlooked. 
We  must  not  lose  sight  of  the  fact  that  "  credit,  in  order  to  be 
solid  and  permanent,  must  have  a  solid  and  permanent  founda- 
tion." 

The  first  care  of  the  architect  who  is  about  to  erect  a  great 
building  is  to  secure  for  it  a  broad  and  firm  foundation. 
Likewise,  in  the  vast  and  continuous  upbuilding  of  a  nation's 
credit,  the  metallic  base  requires  the  most  attentive  and  en- 
lightened consideration.  To  provide  for  it,  the  entire  re- 
sources of  the  State  are  not  too  great.  It  is  difficult  to  under- 
stand how,  in  certain  countries,  an  undertaking  of  such  uni- 
versal interest  should  be  left  to  private  enterprise.  How  can 
the  latter  be  powerful  enough  to  accumulate  holdings  in  cur- 
rency which  may  have  to  remain  idle  for  long  periods,  and 
which  can  unflinchingly  resist  all  assaults  and  all  storms  ? 

In  France  a  system  which  has  already  passed  the  hundred- 
year  mark  and  has  been  particularly  fortunate  as  to  results, 
intrusts  the  Bank  of  France  with  the  duty  of  building  up  and 
preserving  the  metal  holdings,  and  this  great  organisation 
shows  itself  fully  worthy  of  the  confidence  which  the  Govern- 
ment has  always  reposed  in  it.  During  its  long  career  the 
bank  has  never  ceased  to  control  credit  with  rare  foresight 
and  a  remarkably  steady  hand. 

From  1870  up  to  the  present  time  the  cash  holdings  of  the 
Bank  of  France  have  not  ceased  to  grow.  But  the  bank,  of  its 
own  volition,  could  not  have  made  such  an  accumulation. 
The  exchanges  are  usually  in  our  favor,  owing  to  our  position 
as  lenders  to  foreign  countries  and  to  the  extent  of  our  ex- 
ports, and  this  for  many  years  past  has  resulted  in  the  con- 
tinual flowing  of  the  precious  metal  into  the  vaults  of  the 
Bank  of  France. 

In  thirty-five  years  the  amount  of  our  metallic  reserves  has 
increased  almost  threefold.  And  it  is  worthy  of  note  that 
while  the  amount  of  circulation  increases  together  with  that  of 
discounts,  loans,  and  current  accounts,  the  fact  is  nevertheless 


492  THE  FRENCH  BANKING  SYSTEM 

established  that  the  bank  note  tends  to  be  more  and  more  ex- 
clusively represented  by  cash  holdings.  The  silver  holdings 
are  continually  diminishing,  while  the  total  holdings  have  in- 
creased. Indeed,  the  Bank  of  France  avails  itself  of  every 
opportunity  to  relieve  its  coffers  of  this  depreciated  currency. 
Since  1898  a  considerable  portion  of  the  holdings  have  been 
absorbed  by  the  recoinage  of  a  certain  number  of  5-franc 
pieces  into  subsidiary  coins. 

PLACE  OF  THE  BANK  OF  FRANCE  IN  THE  DISTRIBUTION  OF 

CREDIT 

We  purpose  now  to  investigate  the  organs  of  French  credit, 
and  to  assign  to  each  of  these  organs  its  function,  in  order 
then  to  ascertain  what  operations  the  Bank  of  France  can 
perform  and  within  what  limitations.  We  have  therefore  to 
examine  (i)  the  function  of  local  banks  and  of  financial  in- 
stitutions; (2)  in  what  manner  the  Bank  of  France  promotes 
the  free  distribution  of  credit;  (3)  in  what  measure  the  bank 
must  control  credit. 

LOCAL   BANKS   AND   THE   FINANCIAL   INSTITUTIONS 

The  natural  organs  for  the  distribution  of  credit  are  the 
banks,  but  not  alt  are  able  to  spread  it  or  popularise  it  in  the 
same  degree.  Thus  the  "  Haute  Banque  "  (the  great  banking 
interests  of  Paris),  solely  engaged  in  operations  of  higher 
speculation  or  in  international  financial  relations,  does  not  in- 
terest us.  The  function  of  distribution  is  reserved  for  the 
local  banks  and  the  financial  institutions,  while  the  function  of 
the  Bank  of  France  is  to  preside  over  this  distribution. 

Local  banks,  pre-eminent  less  than  one  hundred  years  ago, 
have  gradually  seen  their  field  of  activity  growing  smaller, 
and  a  large  number  of  them  have  been  amalgamated  with 
great  institutions,  possessed  of  much  greater  resources,  with 
branches  over  the  entire  country,  and,  it  must  be  said,  free 
from  the  routine  which  caused  the  downfall  of  many  provincial 
houses.  With  their  decline  we  greatly  regret  to  see  the  dis- 
appearance of  personal  credit,  which  it  is  more  and  more  diffi- 
cult to  make  available.  The  intuitus  personae  (the  judgment 


THE  BANK  OF  FRANCE  493 

of  character),  which  may  serve  as  a  basis  for  credit  granted  to 
a  neighbor  by  a  neighbor,  can  not  be  considered  by  a  cor- 
poration official  who  has  almost  no  means  of  estimating  the 
solvency  of  individuals  except  from  the  material  and  tangible 
side. 

The  local  banks,  as  far  as  they  have  survived,  have  adopted 
methods  which  do  not  bring  them  into  competition  with  their 
powerful  rivals.  They  have  been  obliged  to  grant  long-term 
credits  or  content  themselves  with  being  intermediaries  for 
the  Bank  of  France  in  granting  credits  to  parties  known  to 
them,  generally  farmers  or  small  landed  proprietors,  with  a 
view  to  redisconnting  the  paper.  On  this  point  again  there  is 
cause  to  regret,  if  not  their  disappearance,  at  least  their  efface- 
ment.  The  institutions  for  agricultural  credit,  in  spite  of  all 
the  attention  they  have  received,  have  not  yet  been  able  to 
replace  the  local  banks  in  the  distribution  of  personal  credit 
applied  to  agriculture. 

The  great  financial  institutions,  of  which  the  four  most 
important  are  the  Credit  Lyonnais,  the  Comptoir  National 
d'Escompte  de  Paris,  the  Societe  Generate,  and  the  Credit 
Industriel  et  Commercial,  have  a  much  more  important  part 
in  the  distribution  of  credit.  Thanks  to  their  numerous  agen- 
cies, to  their  attractive  conduct  of  business,  with  the  service 
of  a  courteous  and  attentive  staff,  they  have  gradually  taught 
the  people  new  habits  in  investment  and  confidence  in  credit, 
to  such  a  degree  that  he  who  but  yesterday  hoarded  in  a  stock- 
ing prefers  to-day,  if  not  to  speculate  on  the  Bourse,  at  least 
to  make  deposits  in  the  savings  banks.  The  great  financial 
institutions  have  done  much  to  give  even  the  lowest  classes 
confidence  in  credit,  and  to  introduce  a  system  of  clearing. 

In  closer  contact  with  the  public  than  the  Bank  of  France, 
which  is  restricted  by  having  to  protect  the  reserve  of  which 
we  have  spoken,  these  institutions  are  able  more  readily  and 
effectually  to  reach  and  to  mould  the  public.  But  that  is  not 
their  only  service  nor  the  only  reason  for  their  existence. 
There  are  transactions  which  they  alone  undertake,  which  they 
alone  can  undertake,  and  which  must  be  performed  because 
they  are  in  the  line  of  progress.  These  operations  are  sources 
of  profit  in  the  same  way  as  are  discounts  and  loans  for  the 


494  THE  FRENCH  BANKING  SYSTEM 

Bank  of  France.  Such  are  demand  deposits,  stock-market 
orders,  and  the  flotation  of  securities.  These  operations  can- 
not be  undertaken  by  the  local  banks.  Occupied  for  the  most 
part  with  long-term  dealings,  they  have  no  use  for  deposits 
payable  on  demand.  If  they  should  have  such  deposits,  their 
total  would  never  reach  a  sufficient  proportion  safely  to  permit 
the  investing  of  an  important  amount. 

On  the  other  hand,  the  Bank  of  France  does  not  and,  even 
if  it  wished,  cannot  compete  with  the  financial  institutions  in 
undertaking  such  operations.  Neither  the  acceptance  of  in- 
terest-paying deposits  nor  the  flotation  of  securities  can  come 
within  the  province  of  a  bank  of  issue.  The  flotation  of 
securities  necessitates  a  certain  contingent  responsibility,  and 
the  institutions  which  place  securities  on  the  market  sometimes 
engage  their  credit  for  very  large  sums,  which  are  sufficiently 
guaranteed  by  their  capital,  but  the  credit  which  is  intended 
to  safeguard  the  stability  of  the  bank  note  cannot  be  pledged 
for  that  purpose. 

It  happens  that  the  Bank  of  France  sometimes  transmits 
subscriptions,  but  this  is  a  gratuitous  and  entirely  voluntary 
service.  In  no  case  can  the  bank  take  for  its  own  account 
bundles  of  securities  in  order  to  dispose  of  them  to  the  public. 
The  purchase  and  sale  of  securities,  which  is  so  profitable  a 
business  in  all  financial  institutions,  could  never,  it  is  clear, 
be  a  successful  undertaking  in  the  Bank  of  France.  The 
staff  of  the  bank  has  no  special  information  as  to  the  various 
securities  dealt  in  on  the  Bourse,  and  cannot,  therefore,  give 
valuable  advice.  Its  role  would  apparently  be  confined  to 
handing  out  the  financial  journals  and  passively  awaiting  or- 
ders. If  it  should  act  otherwise,  the  staff  .would  engage 
the  moral  responsibility  of  the  Bank  of  France;  but  the 
bank,  evidently  reluctant  to  undertake  such  operations,  pre- 
fers to  leave  that  field  to  its  auxiliaries,  the  financial  institu- 
tions. 

However,  at  the  present  time,  the  Bank  of  France  tends 
to  compete  with  these  institutions  for  the  purpose  of  main- 
taining sound  conditions  of  credit  which  inclines  more  and 
more  to  speculation.  Thus  it  is  extending  its  department  for 
the  purchase  and  sale  of  securities  in  order  to  safeguard  a 


THE  BANK  OF  FRANCE  495 

poorly  informed  public  against  the  excesses  of  speculation 
which  dazzle  with  the  hope  of  an  always  illusive  gain. 


Thus  the  Bank  of  France  must  leave  entire  freedom  of 
action  to  the  financial  institutions  and  must  not  encroach, 
theoretically  at  least,  on  their  functions,  which,  as  has  been 
shown,  differ  materially  from  its  own.  The  bank  even  owes 
them  its  protection,  since  they  are  valuable  auxiliaries  in  pur- 
suing its  aim  of  extending  credit  as  liberally  as  our  metallic 
base  permits.  In  the  interest  of  the  public  the  cash  holdings 
are  daily  at  their  disposal.  The  help  and  protection  of  which 
we  speak  are  not  mere  passive  professions.  Unfortunately, 
there  have  already  been  numerous  cases  where  the  bank  has 
had  to  interfere  in  order  to  bring  effective  assistance  to  private 
banks.  The  bank  has,  of  course,  acted  thus  for  the  welfare 
of  the  entire  community,  but  also  for  the  satisfaction  of  pro- 
tecting its  auxiliaries  with  all  its  power  in  the  fulfilment  of  a 
difficult  task. 

Let  us  recall  the  failure  of  the  Societe  des  Depots  et  Comptes 
Courants,  in  the  beginning  of  1891. 

"  The  Bank  of  France,  after  exacting  such  security  as  the 
concern  could  still  offer  and,  furthermore,  the  guaranty  of 
several  large  banking  institutions,  for  the  purpose  of  limiting 
possible  losses,  authorised  discounts  to  the  amount  of  49,228,- 
206.87  francs.  Thanks  to  this  assistance,  all  deposits  were 
paid  off,  and  the  dreaded  effects  of  a  panic  were  once  more 
averted."  *  However,  in  spite  of  the  precautions  that  had  been 
taken,  the  liquidation  was  slow. 

Whenever  the  financial  institutions  have  found  themselves 
in  need  of  effective  pecuniary  assistance,  the  Bank  of  France 
has  regarded  it  a  duty  to  help  them,  and  in  normal  times,  by 
assisting  them  with  its  resources,  it  facilitates  liberal  credits. 

1 "  Compte  rendu  de  1'assemblee  generate  des  actionnaires  de  la  Banque 
de  France,"  1891. 


496  THE  FRENCH  BANKING  SYSTEM 


IN  WHAT  MEASURE  THE  BANK   MUST   CONTROL   CREDIT 

It  may  happen  that  the  great  financial  institutions  expand 
too  rapidly  or  unwisely  this  or  that  branch  of  credit.  Mind- 
ful, above  all,  of  their  own  interest,  which  is  but  natural,  they 
have  no  especial  regard  for  the  public  welfare,  their  only  aim 
being  to  make  their  capital  bear  fruit  and  to  pay  large  divi- 
dends to  their  shareholders. 

The  Bank  of  France  aspires  to  a  nobler  ideal,  and  many 
of  its  policies  are  primarily  for  the  public  good.  The  develop- 
ment of  credit  is  an  extremely  delicate  matter;  there  are  many 
instances  where  the  application  of  this  agency  has  led  to  great 
catastrophes.  It  is  undoubtedly  impossible  to  exercise  a  strict 
supervision  over  the  financial  institutions;  any  such  measure 
would  soon  appear  vexatious  and  would  be,  moreover,  con- 
trary to  our  spirit  of  liberty  and  independence.  But  we  can 
quite  justly  ask  whether  these  concerns  are  fully  sheltered 
against  disasters;  whether  nothing  can  happen  to  them  of  a 
nature  to  shake  their  credit;  and  in  such  a  contingency  what 
should  be  the  attitude  of  the  Bank  of  France. 

The  preceding  instance,  and  others  that  might  be  referred 
to,  inform  us  sufficiently  as  to  the  possibility  of  failures.  The 
house  of  Baring  Bros.,  the  Union  Generate,  and  others  enjoyed 
an  immense  credit,  thought  to  be  unshakable,  and  the  events 
of  a  day  flatly  contradicted  that  opinion. 

In  the  course  of  the  discussion  concerning  the  last  renewal 
of  the  charter  of  the  Bank  of  France,  much  was  said  as  to 
the  possibility  of  allowing  a  certain  interest  to  depositors  in  the 
bank.  .  .  .  M.  Burdeau  1  has  shown  that  it  is  impossible  for 
the  Bank  of  France  to  become  a  bank  of  deposit.  The  issue 
of  bank  notes  and  the  receipt  of  interest-bearing  deposits  are 
absolutely  incompatible  services.  Their  union  in  a  single  hand 
"  would  replace  the  present  organization  by  an  entirely  new 
one,  which,  in  case  of  a  crisis,  would  offer  much  less  vitality 
and  power  of  resistance."  For  us  it  is  sufficient  to  know  that 
the  payment  to  depositors  of  i  per  cent,  on  deposits  subject 
to  check  would  attract  to  the  bank  nearly  all  inactive  funds. 

1  Burdeau,  "  Discours  sur  1e  renouvellement  du  privilege  de  la  Banque 
de  France,"  June  29  and  July  6,  1892,  in  the  Officiel  of  June  30  and  July  7- 


THE  BANK  OF  FRANCE  497 

and  that  a  sum  in  the  neighbourhood  of  1,000,000,000 
francs  would  leave  the  private  banks.  This  would  be  their 
death-blow  —  a  result  which  we  are  unwilling  to  contem- 
plate. 

By  their  very  nature  the  financial  institutions  are  liable  to 
weakness,  and  for  the  public  good  there  must  be  some  means 
of  supporting  them.  For  this  reason  the  Bank  of  France, 
which  presides  over  the  distribution  of  credit,  can  permit  the 
expansion  of  its  auxiliaries  only  up  to  the  point  where  its  help 
would  suffice  to  prevent  the  collapse  of  the  market.  Such  a 
measure  appears  imperative  in  a  country  where  the  protecting 
wisdom  of  the  Bank  of  France  has  always  been  relied  upon. 
Fortunate  land,  fortunate  institution,  which  excites  the  envy 
of  foreigners,  especially  of  England,  where  the  least  failure 
may  result  in  disastrous  consequences. 

Thus  the  banks  of  deposit  have  contributed  to  progress  by 
gathering  and  giving  life  to  sums  previously  lying  scattered 
and  idle.  They  are  valuable  auxiliaries  in  the  distribution  of 
credit.  For  this  reason  they  deserve  help  and  protection. 
The  bank,  the  mission  of  which  is  of  a  wider  and  loftier  scope,1 
has  shown  on  many  occasions  that  its  helpfulness  is  not  a  pre- 
tence ;  daily,  in  fact,  it  assists  them  by  rediscounting  their  bills. 
The  prosperity  of  the  financial  institutions  has  continually  in- 
creased. It  is  associated  with  the  confidence  and  growing 
security  of  our  times.2  But  the  bank  must  be  ready  to  meet 
even  improbable  contingencies  in  order  to  be  in  a  position  to 
recapture  the  market  with  a  sure  hand  as  soon  as  danger  threat- 
ens it. 

Under  these  circumstances,  what  can  the  bank  do?  In  the 
first  place,  it  can  utilise  its  powerful  reserve  which  has  been 
accumulated  for  this  purpose.  It  can,  in  the  next  place,  curb 

1  The  Bank  of  France,  during  periods  of  quiet  and  prosperity,  aims  at  a 
gradual  effacement,  at  a  more  complete  retreat  toward  a  very  high  but 
very   restricted    sphere   of   economic   activity.     But  as   soon  as   the  least 
trouble  appears  ...  the  Bank  assumes  again  its  place  at  the  head  of  our 
great  financial  institutions.     (Brouilhet,  "  Le  nouveau  regime  de  la  Banque 
de  France,"  Revue  d'Economie  Politique,  1899.) 

2  The  discounts  and  loans  of  the  financial  institutions  are  growing  in 
importance,   and   are   steadily   increasing   in   proportion    to   those   of   the 
Bank.     This  condition,  revealed  by  statistics,  is  in  itself  not  alarming,  but 
it  once  more  justifies  that  intervention,  so  many  motives  for  which  we  have 
brought  out. 


498  THE  FRENCH  BANKING  SYSTEM 

the  action  of  the  banks  by  competing  with  them  when  they 
appear  to  enter  upon  a  dangerous  course,  and  by  showing  them 
what  steps  to  take.1 

On  the  other  hand,  there  is  a  whole  series  of  operations  which 
private  banks  do  not  undertake,  or  do  not  tend  to  develop  as 
they  deserve.  Directed  by  self-interest  toward  the  more  prof- 
itable transactions,  they  somewhat  neglect  the  others.  The 
Bank  of  France  finds  no  one  engaged  in  these  less  remunera- 
tive operations,  and  is,  moreover,  the  better  able  to  undertake 
them  itself,  because  they  are  not  incompatible  with  the  duties 
of  a  bank  of  issue. 

Foremost,  perhaps,  among  these  operations  is  the  popular- 
ising of  credit  by  means  of  an  ever  increasing  number  of  small 
loans,  frequently  accepting  as  pledge  securities  such  as  State 
rentes,  bonds  of  the  Credit  Foncier,  of  cities,  railroads,  and 
industrials.  An  enormous  transfer  business  is  also  carried 
on  for  both  banks  and  the  public  at  very  low  cost.  Moreover, 
the  bank  clears  large  sums,  annually  relieving  the  clearing 
house  of  this  burden. 

The  small  business  man,  much  more  than  the  small  rentier, 
reaps  continually  greater  benefit  from  the  advantages  offered 
to  the  public  by  the  Bank  of  France.  We  shall  here  simply 
call  to  mind  the  dates  of  some  innovations  favorable  to  the 
democratisation  of  credit. 

January  15,  1824. —  Creation  of  transfer  drafts. 

April  29,  1824. —  Creation  of  transferable  certificates  of  de- 
posit. 

January  13,  1830. —  Reduction  of  interest  on  loans  against 
bars  and  coin  from  4  per  cent,  to  I  per  cent. 

1834. —  Loans  against  rentes  and  public  securities. 

1837. —  Daily  discounting  of  paper  except  on  holidays. 

Law  of  June  30,  1840,  article  2. —  Option  of  replacing  the 
third  signature,  exacted  for  discount,  by  deposit  of  any  French 
public  securities. 

1  It  seems  that  this  protective  mission  especially  applies  to  the  depart- 
ment for  stock  market  orders,  originally  reserved  for  the  customers  of 
the  Bank,  and  later  opened  to  everybody.  Thus  it  prevents  the  financial 
institutions  from  driving  us  toward  excessive  speculation.  This  purpose 
explains,  according  to  our  notion,  the  growth  and  broadening  of  the 
business  of  stock  market  orders  at  the  Bank  of  France. 


THE  BANK  OF  FRANCE  499 

Decree  of  March  26,  1848. —  Similar  option  of  replacing  by 
warehouse  receipts. 

Law  of  November  17,  1897. —  Admission  of  bills  for  dis- 
count carrying  the  signature  of  an  agricultural  syndicate.  The 
minimum  for  bills  discounted  is  reduced  to  5  francs. 

There  is  here  a  whole  series  of  measures,  which,  with  the 
assurance  of  a  cordial  welcome,  should  induce  the  small  busi- 
ness man  to  trade  with  the  bank. 

The  bank  accepts  large  quantities  of  small  paper  with  small 
signatures,  and  it  finds  itself,  accordingly,  in  normal  times 
deprived  of  first-rate  paper,  of  that  which  is  as  good  as  gold 
in  international  commerce.  Gilt-edged  paper  always  finds  its 
market  at  lower  rates  than  in  the  bank,  and  M.  d'Eichthal,  a 
regent  of  the  bank,  wrote  as  far  back  as  fifty  years  ago: 
"  Whatever  may  be  the  discount  rate,  among  the  bills  dis- 
counted there  will  be  found  but  few  with  the  signatures  of  the 
Rothschilds,  the  Hottinguers,  and  other  houses  of  the  same 
rank.  Those  are  delicacies  which  always  command  a  pre- 
mium." 1.  .  . 

The  bank  has  always  resolutely  undertaken  to  carry  through 
a  whole  series  of  operations  which  could  not  show  great  profit; 
above  all,  it  has  unremittingly  aimed  to  be  of  service  to  the 
greatest  number.  The  number  of  bills  discounted  grows  con- 
tinuously, while  the  total  amounts,  smaller  during  the  most 
prosperous  periods,  invariably  increase  in  periods  of  tight 
money.  The  average  amount  and  term  of  bills  is  600  francs 
for  twenty  days.  This  result  would  be  considerably  modified, 
if  we  were  to  take  into  account  the  bills  handed  in  for  collec- 
tion only,  the  average  value  of  which  hardly  exceeds  200  to 
250  francs. 

TERRITORIAL  EXPANSION  OF  THE  BANK  OF  FRANCE 

With  its  growth  in  extent  the  bank  has  not  only  developed 
its  services  to  meet  new  business  needs,  by  providing  an  in- 
creased staff,  and  larger,  more  attractive,  and  better  conducted 
offices,  but  it  has  also  endeavored  to  reach  a  more  and  more 
widely  extended  territory.  Indeed,  the  mere  fact  that  the 

1  P.  Coq,  "  Les  circulations  en  Banque,"  Paris,  Guillaumin,  1865,  p.  38. 


500  THE  FRENCH  BANKING  SYSTEM 

bank  has  entered  a  place,  if  only  to  make  collections  there, 
gives  a  favorable  turn  to  credit  conditions ;  credit  becomes 
cheaper,  in  that  the  basis  for  money  rates  becomes  the  official 
discount  rate,  because  the  financial  institutions  have  then  a 
more  economical  method  of  replenishing  their  cash.  The 
smallest  provincial  town  where  the  bank  has  entered  is,  there- 
fore, in  regard  to  low  money  rates,  as  favored  as  Paris. 

Exchange  between  cities,  particularly  when  joined  with  a 
special  commission,  reaches  sometimes  a  considerable  sum.  As 
soon  as  the  bank  opens  its  branch,  exchange  is  no  longer  pos- 
sible. Therefore,  whenever  the  charter  of  the  bank  has  been 
renewed,  the  legislator,  in  response  to  the  wishes  of  the  pub- 
lic, has  wisely  required  new  territorial  expansion  of  the  bank. 
If  the  bank  has  not  always  taken  the  initiative  in  this  mode 
of  expansion,  it  is  because  it  has  been  restrained  by  several 
motives.  In  the  first  place,  the  opening  of  new  offices  entails 
considerable  expense.  It  is  necessary  to  count  upon  several 
years  of  deficit,  during  which  the  running  expenses,  including 
salaries  of  staff,  are  just  as  high  as  if  the  profits  were  large. 
We  could  name  several  cities  which  for  years  have  shown  con- 
stant deficits.  It  can  therefore  be  understood  that  the  Bank 
of  France,  which  is  already  established  in  the  200  towns  most 
important  from  a  commercial  standpoint,  and  which,  by 
means  of  its  collecting  department,  touches  265  towns  of  less 
importance,  extends  its  service  only  with  caution  to  new  lo- 
calities, since  each  new  branch  must  necessarily  produce  a 
larger  and  more  persistent  deficit.  Thus  territorial  expansion 
is  for  the  bank  an  ever-increasing  burden ;  it  is  equivalent  to 
an  additional  tax  imposed  by  the  legislature  at  every  rene\val 
of  the  charter.  The  bank  submits  to  this  with  good  grace  for 
the  benefit  of  the  public. 

In  the  second  place,  there  is  a  limit  to  that  expansion. 
Where  the  bank  has  no  branches,  the  financial  institutions  may 
take  root  and  develop  among  a  population  which  appreciates 
their  services.  Their  profits  come  largely,  it  appears,  from 
small  towns,  where  competition  is  less  keen.  We  have  already 
said  enough  concerning  the  service  of  these  institutions  in  the 
development  of  French  credit  to  show  the  danger  of  inflicting 
upon  them  fresh  injury.  On  whatever  side  the  bank  desires 


THE  BANK  OF  FRANCE  501 

to  expand  it  finds  this  limit.  If  the  bank  encroaches  a  little 
on  all  sides,  the  result  may  be  very  appreciable. 

The  territorial  expansion  is  further  perceptibly  increased  by 
what  is  known  in  the  bank  as  the  exterior  accounts.  This  sys- 
tem, of  quite  recent  origin,  allows  any  person  not  residing  in 
the  town  where  the  branch  is  established  to  enjoy  the  same 
privileges  as  residents.  Business  may  be  transacted  by  mail 
with  the  aid  of  certain  accounting  forms,  which  often  differ 
from  those  used  for  ordinary  accounts.  Each  transaction  is 
the  subject  of  a  special  report,  addressed  to  the  customer  by 
the  branch.  Not  only  is  the  transaction  itself  reported,  but 
useful  information  as  to  the  position  of  the  account  is  also 
given,  thus  permitting  the  customer  to  follow  the  movement 
of  the  account  until  the  half-yearly  statement  is  sent. 

This  department  is  highly  esteemed  by  the  suburban  public, 
and  renders  many  services  to  landed  proprietors  and  to  farm- 
ers, especially  in  the  cattle-raising  trade. 

Thus  the  direct  expansion,  which,  as  has  been  seen,  meets 
\vith  serious  obstacles,  is  assisted  by  this  indirect  expansion.1 

Evidently  we  are  far  from  realising  the  attractive  dream 
of  a  France  no  longer  deprived  in  part  of  banking  facilities, 
but  with  all  bills  taken  at  par  because  the  bank  would  reach 
everywhere.  But  for  the  sake  of  this  end,  no  doubt  desirable 
in  itself,  is  it  w:orth  \vhile  to  go  to  extremes  for  a  scarcely 
perceptible  advantage,  to  disturb  an  institution  in  other  re- 
spects strong  and  useful,  and  thus  perhaps  to  risk  disorgan- 
ising the  general  credit  system  of  France?  On  the  contrary, 
wre  should  be  content  with  and  even  congratulate  ourselves 
upon  a  progress  which  leads  us,  slowly  perhaps,  but  surely, 
toward  the  realisation  of  credit  on  low  terms  everywhere  and 
for  all. 

THE  BANK  OF  FRANCE  AND  AGRICULTURAL  CREDIT 

"  There  is  no  such  thing  as  agricultural  credit ;  there  is  only 
credit,"  said  M.  Dupin  in  i845.2  Matters  have  not  changed 

!The  indirect  expansion  might  be  increased  by  wider  use  of  the 
"crossed  check."  It  will  be  long  before  we  may  expect  good  results 
from  this  practice,  since  we  are  as  yet  too  far  from  the  time  when  this 
check,  almost  unknown  in  France,  will  be  currently  used. 

2  Journal  Officiel,  1845,  p.  2471. 


502  THE  FRENCH  BANKING  SYSTEM 

since.  It  is  certain,  for  instance,  that  Scotland,  vyhich  for  a 
long  time  was  the  classical  land  of  pauperism,  owes  its  pros- 
perity to  the  banks,  which,  by  developing  credit  in  favor  of 
agriculture,  have  entirely  transformed  the  soil  and  the  coun- 
try. Indeed,  more  than  any  other,  the  Scotch  farmer  needed 
credit,  and  more  than  any  other  he  has  benefited  by  it.  It 
may  be  said  that  personal  credit  is  peculiar  to  agriculture. 
Thus  it  suffered  as  a  result  of  the  evolution  already  mentioned, 
which,  by  causing  the  disappearance  of  local  banks  or  by  giv- 
ing them  a  new  direction,  struck  a  fatal  blow  to  personal 
credit. 

We  know  that  "  agricultural  credit "  includes  loans  from 
seed-time  to  harvest.  The  first  labor  done,  the  first  loan 
made  to  the  land  can  only  be  repaid  much  later.  The  aver- 
age time  necessary  for  agricultural  loans  is  five  or  six  months 
at  least.  Now,  for  other  reasons  the  by-laws  of  the  bank 
prohibit  the  discounting  of  paper  having  more  than  ninety 
days  to  run.  By  a  special  favor  which  would  not  be  accorded 
in  business,  where  each  loan  has  a  different  object,  the  bank 
allows  the  renewals  necessary  for  agricultural  loans,  which 
almost  exclusively  take  the  form  of  bills  payable  to  order. 
The  bill  returned  to  the  maker  on  the  day  of  maturity  is  re- 
newed the  following  day.  The  date  of  maturity  alone  is 
changed. 

A  very  important  agricultural  industry,  \vhich  we  have  al- 
ready mentioned,  is  that  of  cattle-raising.  The  cattlemen  are, 
for  the  most  part,  customers  of  the  bank  wherever  it  has  a 
branch.  This  customer  of  a  somewhat  special  kind  appears, 
by  the  very  nature  of  his  trade,  to  be  indicated  as  a  suitable 
client  for  the  bank  and  not  for  the  financial  institutions.  The 
bank  permits  the  cattlemen  to  indorse  each  other's  paper,  and 
thus  can  accommodate  them  without  intermediaries.  There 
results  a  very  useful  co-operation.  Moreover,  by  using  the 
bank  the  cattlemen  effect  great  savings,  the  full  value  of  which 
they  alone  can  estimate. 

After  the  law  of  July  18,  1898,  and  the  legislation  that  fol- 
lowed, it  might  have  been  expected  that  the  use  of  agricultural 
warehouse  receipts  would  be  greatly  extended.  This  legisla- 
tion makes  a  serious  exception  to  the  common  law  for  the 


THE  BANK  OF  FRANCE  503 

benefit  of  agriculture.  It  "  constitutes  the  landowner,  so  to 
speak,  a  public  warehouse.  It  is  he  who,  without  any  other 
controlling  appraisement,  makes  declaration  as  to  quantity  and 
commercial  value  to  the  clerk  of  the  justice  of  the  peace.  In 
short,  the  agriculturist  enjoys  a  confidence  which  so  far  has 
been  denied  to  industry  and  commerce."  Notwithstanding 
this  favor,  the  agricultural  warehouse  receipts  are  little  used,1 
and  the  bank,  despite  its  willingness  to  take  them  freely,  re- 
grets to  find  them  among  its  discounts  in  such  very  small 
number. 

Our  survey  would  not  be  complete  should  we  fail  to  say  a 
word  concerning  the  agricultural  credit  associations,  of  which 
also  much  was  expected  and  which  have  only  in  a  very  limited 
measure  fulfilled  the  high  hopes  of  their  founders.2 

For  the  support  of  agricultural  credit  the  State  draws  from 
two  sources  the  funds  required  to  supply  the  organs  of  distri- 
bution, the  local  and  regional  associations.  The  first  source  is 
the  loan  of  40,000,000  francs  made  by  the  bank  on  November 
17,  1897,  when  the  charter  was  renewed.  This  amount,  like 
the  140,000,000  francs  already  advanced  in  1857  and  1878, 
bears  no  interest.  The  second  source  is  the  yearly  payment 
made  by  the  Bank  of  France  on  the  profit-yielding  circulation. 
This  payment  cannot  be  less  than  2,000,000  francs  yearly, 
and  more  often  it  is  in  the  neighborhood  of  5,000,000  francs. 

All  these  sums,  intended  for  agriculture,  are  distributed  by 
the  Government,  and  are  used  in  endowing  the  associations 
of  agricultural  credit.  The  regional  associations,  which  are 
the  pivot  of  the  present  organisation,  are  self-governing  soci- 
eties, with  a  capital  of  their  own.  This  capital,  added  to  the 
advance  made  by  the  State,  is  invested  in  first-class  securities, 

aThe  main  reason  lies  in  the  numerous  formalities  which  the  law  of 
April  30,  1006,  has  simplified  but  not  suppressed,  in  the  many  expenses 
caused  by  the  organisation,  and  also,  it  appears,  in  the  inexperience  of 
some  of  the  officials.  The  clerks  of  the  justices  of  the  peace,  intrusted 
with  the  delicate  and  novel  functions  of  registrars  of  chattel  mortgages, 
are,  as  a  rule,  little  fitted  to  perform  them. 

2  The  model  of  these  institutions  came  to  us  from  foreign  countries: 
but  the  foreign  differ  from  ours  materially,  because  of  the  diversity  of 
their  origin.  With  our  neighbors,  the  movement  began  slowly  in  the 
lowest  levels  of  the  rural  population.  With  us,  on  the  contrary,  the  sys- 
tem of  agricultural  associations  began  at  the  top.  Thus,  these  institu- 
tions penetrate  only  with  difficulty  into  the  rural  districts,  where  economic 
education  has  but  just  begun. 


504  THE  FRENCH  BANKING  SYSTEM 

which  are  then  deposited  in  the  Bank  of  France,  as  discount 
guarantee  to  take  the  place  of  the  third  signature,  if  need  be. 
The  local  offices  send  their  paper  to  the  regional  office,  which 
then  takes  it  to  the  bank,  as  the  needs  of  funds  are  felt. 

Such  is  the  part  of  the  Bank  of  France  in  the  distribution  of 
agricultural  credit.  Effective  intervention  was  obviously  very 
difficult,  yet  the  bank  has  contrived,  even  beyond  its  legal  obli- 
gations, to  give  the  benefit  of  its  credit  to  agriculture,  which 
so  justly  deserves  the  care  it  is  receiving. 

THE  BANK  OF  FRANCE 

INTERVIEW  WITH  M.  PALLAIN,  GOVERNOR  OF  THE  BANK 
OF  FRANCE  * 

Q.  Is  the  Bank  of  France  ever  attacked  in  the  controversies 
between  political  parties? 

A.  No  charge  has  ever  been  made  that  the  bank  favored  or 
aided  any  political  party.  There  is  never  any  claim  that  poli- 
tics enters  in  any  degree  into  the  management  of  the  bank. 

Q.  Is  the  capital  entirely  private  property  ? 

A.  Yes.  All  the  shares  are  divided  between  30,000  share- 
holders, of  whom  about  10,000  have  not  more  than  one  share. 

Q.  How  are  your  branches  managed? 

A.  All  branches  are  managed  by  a  manager,  assisted  by  a 
local  board  of  directors,  selected  from  among  the  best  qualified 
commercial,  industrial,  and  agricultural  representatives  in  the 
region. 

Q.  Do  the  branches  have  business  relations  with  the  mer- 
chants, farmers,  and  all  classes  of  people  of  the  locality? 

A.  Yes,  they  are  open  to  everybody. 

Q.  You  have,  I  suppose,  in  the  branches  regular  clients 
who  have  an  account  with  you? 

A.  Yes,  and  a  considerable  number  of  them. 

Q.  Do  your  branches  do  the  same  kind  of  business  as  the 
branches  of  the  Credit  Lyonnais? 

A.  The  Bank  of  France  and  its  numerous  branches  do  all 

1  Adapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 
England,  Scotland,  France,  Germany,  Switzerland,  and  Italy,  Publications 
of  the  National  Monetary  Commission,  Senate  Document  No.  405,  6lst 
Congress,  2nd  Session,  pp.  189-218. 


THE  BANK  OF  FRANCE  505 

banking  business  consistent  with  the  laws  properly  regulating 
a  bank  of  issue. 

Q.  A  bill  drawn  in  New  York  on  France,  on  a  bank,  for  in- 
stance, the  Credit  Lyonnais,  at  Paris,  and  accepted  by  it,  would 
it  be  admissible  for  discount? 

A.  Yes,  if  it  bore,  besides  the  signature  of  the  French  estab- 
lishment accepting  it,  at  least  one  other  French  signature; 
that  of  the  person  presenting  it,  for  instance,  having  a  current 
account  at  the  Bank  of  France. 

Q.  A  part  of  your  portfolio  comes  from  rediscounting  for 
banks  ? 

A.  Certainly,  and  it  is  an  important  part. 

Q.  Could  you  give  us  an  estimate  of  the  proportion  of  bills 
which  are  discounted  for  banks  and  those  discounted  for  other 
customers  ? 

A.  I  should  estimate  that  about  70  per  cent,  of  the  paper 
now  held  bears  the  signature  of  some  bank  as  one  of  the  in- 
dorsers;  but  it  is  manifest  to  us  that  the  number  of  merchants 
and  manufacturers  who  appreciate  the  facilities  given  by  the 
bank  for  direct  discounting  and  who  profit  by  it  increases  per- 
ceptibly every  day. 

Q.  Does  the  Bank  of  France  make  the  same  charge  for  the 
discount  of  bills  and  for  loans  upon  collateral? 

A.  The  bank  usually  charges  somewhat  more  for  loans  upon 
collateral  than  for  the  discount  of  bills.  The  rates  at  present 
are  3  per  cent,  and  4  per  cent.,  respectively. 

Q.  Could  we  obtain  an  estimate  of  the  percentage  of  the 
deposits  of  the  other  banks  at  the  Bank  of  France  in  com- 
parison with  the  whole  of  such  deposits? 

A.  In  the  credit  establishments  which  you  will  visit  you 
will  be  able  to  establish  the  fact  that  the  liquid  cash  is,  in  com- 
parison with  their  turnover,  relatively  very  small.  In  France 
we  consider  that  the  strength  of  a  bank  consists  more  in  the 
composition  of  its  portfolio,  i.  e.,  in  the  value  of  its  com- 
mercial bills,  rather  than  in  the  importance  of  its  cash 
reserve. 

Q.  Is  the  amount  of  all  taxes  paid  by  the  bank  to  the  State 
included  in  your  report? 

A.  Yes.     The  public  charges  of  the  bank  in  1907  were  more 


506  THE  FRENCH  BANKING  SYSTEM 

than  11,000,000  francs,  whereas  the  profits  distributed  were 
31,000,000  francs. 

Q.  Have  you  a  system  of  transfers  similar  to  that  used  by 
the  Reichsbank? 

A.  Yes,  this  system,  in  France,  dates  as  far  back  as  a  cen- 
tury or  more. 

Q.  What  is  your  method  of  transfer? 

A.  Transfers  from  place  to  place  are  made  by  simple  noti- 
fication to  branches. 

Q.  Are  the  other  banks  accustomed  to  use  the  Bank  of 
France  in  order  to  transfer  their  funds? 

A.  The  greater  part  of  the  banks  use  no  other  method,  even 
to  increase  the  cash  in  one  of  their  branches  in  a  remote  part 
of  France. 

Q.  Is  the  Bank  of  France  subject  to  examination  by  the 
Government  ? 

A.  There  is  no  regular  system  of  examination,  but  the  Min- 
ister of  Finance  has  the  right  to  ask  for  information  when- 
ever he  chooses. 

Q.  Is  the  Bank  of  France  regarded  as  a  bank  for  banks  or 
as  a  bank  for  the  people  ? 

A.  The  Bank  of  France  remained  for  a  long  time,  indeed, 
the  bank  for  banks,  but  since  it  has  covered  so  much  territory 
with  its  numerous  branches;  since  the  minimum  amount  of 
all  its  operations  has  been  lowered ;  since  it  has  opened  deposit 
accounts  to  all,  it  is  already  and  it  tends  to  become  more  and 
more  —  as  you  ask —  the  bank  of  all  the  French  public. 

Q.  Is  there  any  contention  in  banking  or  economic  circles 
that  it  is  necessary  to  restore  or  extend  the  right  of  issue  to 
banks,  other  than  the  Bank  of  France,  to  enable  them  to  in- 
crease their  own  profits  or  to  afford  adequate  facilities  to  bor- 
rowers or  to  meet  legitimate  business  demands? 

A.  The  unity  of  issue  was  achieved  in  France  in  1848,  and 
at  no  time  since  then  has  there  been  any  question,  in  responsi- 
ble circles,  of  a  possible  return  to  plurality  of  issue.  The 
same  tendency  is  leading,  little  by  little,  to  an  absolute  monop- 
oly in  England,  Germany,  and  even  in  Italy.  I  think  that  it 
would  also  be  interesting  for  you  to  examine  the  recent  exam- 
ple of  Switzerland,  which  had  its  note-issue  system  founded, 


THE  BANK  OF  FRANCE  507 

as  in  America,  on  the  plurality  of  banks  and  which  has  now 
substituted  for  this  system  one  single  privileged  bank.  This 
transformation  has  received  popular  approval  by  referendum. 

Q.  Does  the  export  of  gold  reduce  the  volume  of  notes? 

A.  Not  necessarily.  It  may  happen  that  among  our  assets 
a  certain  fraction  of  the  gold  is  replaced  by  an  equal  amount 
of  bills  in  our  portfolio,  and  that  without  changing  the  total 
of  notes  in  circulation. 

Q.  There  is  nothing  in  the  law  requiring  your  notes  to  be 
covered  by  a  certain  proportion  of  gold? 

A.  No  regulation  of  this  kind  exists  in  our  legislation. 

Q.  Do  you  rely  upon  raising  the  rates  of  discount  to  stimu- 
late the  importation  and  to  prevent  the  exportation «of  gold? 

A.  It  is  a  principle  consecrated  by  experience  that  the  su- 
preme means  of  defence  for  an  issue  bank,  to  protect  its  metal- 
lic reserve,  is  to  raise  the  rate  of  discount,  and  we  never  lose 
sight  of  this  principle.  However,  the  extent  of  our  reserves 
allows  us  to  contemplate  without  emotion  important  varia- 
tions of  our  metallic  stock,  and  we  only  exceptionally  have 
recourse  to  a  measure  which  is  always  painful  for  commerce 
and  industry.  The  stability  and  the  moderation  of  the  rate 
of  discount  are  considered  as  precious  advantages,  which  the 
French  market  owes  to  the  organisation  and  traditional  con- 
duct of  the  Bank  of  France. 

Q.  Would  you  like  to  express  an  opinion  as  to  why  the 
Bank  of  France  is  able  to  hold  its  gold  with  a  bank  rate  of 
4  per  cent,  when  the  rates  elsewhere  are  higher  ? 

A.  The  causes  of  this  phenomenon  are  multiple.  Theory 
teaches  us  that  capital  goes  where  it  can  obtain  the  highest 
remuneration,  but  in  considering  this  remuneration  account 
must  be  taken  of  risks;  these  are  numerous  and  of  different 
kinds ;  I  mean,  of  course,  commercial  risks ;  risk  of  losing  on 
exchange  when  the  capital  is  brought  back,  etc.  This  at  once 
explains  why  it  is  possible  in  France  to  maintain  a  rate  of  dis- 
count lower  than  elsewhere.  French  capitalists  might  fear, 
perhaps,  that  the  higher  interest  obtainable  outside  might  be 
offset  or  more  than  offset  by  the  risks  incurred.  Account 
must  be  taken,  secondly,  of  the  situation  always  held  by  France 
as  a  creditor  nation,  and  which  by  the  constant  income  of  capi- 


508  THE  FRENCH  BANKING  SYSTEM 

tal  which  it  assures  to  us  certainly  contributes  to  counter-bal- 
ance the  current  of  exportation  which  might  result  from  the 
lowering  of  the  rate  of  discount. 

Q.  Does  the  Bank  of  France  sometimes  take  steps  to  main- 
tain the  bank  rate  by  the  purchase  of  bills  in  the  market  or 
otherwise? 

A.  No,  never. 

Q.  The  tradition  and  the  reputation  of  the  Bank  of  France 
make  it  important  that  it  should  hold  a  larger  reserve  than  any 
other  bank  in  the  world? 

A.  It  is  true  that  France  keeps  locked  up  in  its  bank  a  pro- 
portionately larger  amount  of  specie  than  any  other  country, 
but  this  policy  is  not  without  important  compensations.  Sup- 
pose the  French  public,  changing  its  mind,  should  reduce  by 
one-half  its  monetary  reserve  of  which  the  bank  is  the  guar- 
dian. It  would  gain  thereafter  the  interest  on  perhaps  two 
milliards  of  francs  released  and  which  would  have  become 
productive  —  that  is  to  say,  a  saving  of  from  80  to  100  mil- 
lions of  francs  per  year  at  the  maximum  —  but  if  one  reflects 
that  it  would  lose  the  advantage  of  the  reduced  rates  of  dis- 
count which  the  extent  and  character  of  our  reserves  enable 
us  to  maintain  and  from  which  all  French  production  profits ; 
that  it  would  lose,  in  addition,  the  sentiment  of  absolute  se- 
curity, of  complete  financial  independence,  which  every  crisis 
has  strengthened,  one  would  be  less  tempted  to  conclude  — 
with  certain  critics  —  that  the  policy  of  maintaining  heavy  re- 
serves, the  natural  expression  of  the  country's  instincts,  is  an 
unwise  policy  from  an  economic  and  practical  standpoint. 

Q.  You  have,  I  believe,  no  requirement  of  law  by  which 
the  Bank  of  France  is  obliged  to  purchase  gold  at  a  certain 
fixed  price? 

A.  The  bank  buys  gold  according  to  the  tariff  of  the  Mint, 
but  it  is  not  obliged  to  do  so.  Private  individuals,  instead  of 
having  their  money  coined  for  themselves,  find  it  more  advan- 
tageous to  sell  their  ingots  to  the  bank,  which  has  them  coined 
when  needed. 


CREDIT  LYONNAIS  '509 


THE  CREDIT  LYONNAIS 

INTERVIEWS  WITH  BARON  BRINCARD,  ADMINISTRATED 
DELEGUE,  AND  OTHER  OFFICIALS  OF  THE 

CREDIT   LYONNAIS  * 

Q>.  What  is  the  date  of  the  organisation  of  the  Credit  Lyon- 
nais? 

A.  July  6,  1863. 

Q.  Under  what  law  was  it  organised? 

A.  We  are  under  the  general  law,  a  general  companies  law. 

Q.  What  is  the  minimum  amount  of  capital  required? 

A.  There  is  no  minimum,  but  at  least  one-fourth  of  the 
capital  is  required  by  law  to  be  actually  paid  in. 

Q.  How  many  shareholders  have  you  ? 

A.  Our  capital  is  divided  into  500,000  shares,  but  as  many 
of  these  shares  are  issued  to  "  bearer  "  we  do  not  know  how 
many  shareholders  we  have. 

Q.  The  cash  in  hand  is  merely  carried  for  the  necessities  of 
business  ? 

A.  Yes.  Any  bank,  if  it  has  need  for  additional  cash,  may 
present  for  rediscount  at  the  Bank  of  France  the  bills  and 
other  commercial  paper  which  it  has  in  its  vaults. 

Q.  What  per  cent,  of  your  deposits  do  you  intend  to  carry 
in  cash  either  in  your  own  vaults  or  in  other  banks  ? 

A.  Eight  to  10  per  cent,  on  the  average. 

O.  Does  the  Bank  of  France  ever  loan  below  its  published 
rate? 

A.  No.     It  never  does. 

Q.  It  is  not,  I  believe,  the  policy  of  your  bank  to  buy  public 
securities  in  large  amounts  ? 

A.  No.  Our  idea  is  to  buy  all  the  commercial  paper  that 
we  can  get  That  is  our  business.  At  present  it  is  almost 
impossible  to  get  any  commercial  paper  because  business  is  so 
slack;  therefore,  we  are  obliged  to  go  outside  and  buy  treasury 
bills. 

1Adapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 
England,  Scotland,  France,  Germany,  Switzerland  and  Italy,  Publications 
of  the  National  Monetary  Commission,  Senate  Document  No.  405,  6ist 
Congress,  2nd  Session,  pp.  219-248. 


510  THE  FRENCH  BANKING  SYSTEM 

Q.  To  what  kinds  of  banks  do  you  lend  on  collateral? 

A.  Mostly  foreign  banks;  for  instance,  banks  in  New  Or- 
leans during  the  cotton  season.  It  is  not  to  our  interest  ta 
lend  to  French  banks.  We  lend  money  to  foreign  banks  and 
to  French  merchants,  but  never  to  foreign  merchants  or  to 
French  banks.  We  never  lend  on  real  estate.  That  is  the 
business  of  the  Credit  Foncier. 

Q.  Do  you  own  all  of  the  securities  you  sell,  or  do  you 
take  orders  and  buy  and  sell  them  on  commission? 

A.  The  greater  part  of  our  transactions  are  made  on  com- 
mission. 

Q.  In  your  statement  of  liabilities  you  show  deposits  about 
$132,000,000,  and  current  accounts  about  $168,000,000. 
Will  you  kindly  explain  the  difference  between  these  two  ac- 
counts ? 

A.  Deposits  are  sums  of  money  deposited,  especially  by 
private  people.  Accounts  current  represent  the  balances  to 
the  credit  of  business  people. 

Q.  If  I  come  here  and  open  an  account  with  you  and  make 
a  deposit  and  say  I  want  to  transact  business  with  you,  bor- 
rowing money  from  time  to  time,  and  depositing  and  drawing 
daily,  would  you  put  that  account  in  your  "  accounts  cur- 
rent"? 

A.  If  you  were  not  a  merchant,  you  would  have  a  deposit 
account  opened  for  your  daily  deposits  and  drawings.  Your 
account  could  never  show  a  debit  balance  and  the  amounts 
which  you  might  borrow  would  have  to  be  secured  by  deposit 
of  securities  and  would  be  placed  under  the  item  "  loans  on 
securities.''  If  you  were  a  merchant,  an  account  current 
would  be  opened  for  the  requirements  of  your  business,  and 
this  account  could  become  debtor. 

Q.  Deposits  and  current  accounts  are  payable  on  demand? 

A.  Yes;  on  demand.  Deposits  are  made  up  of  sums  de- 
posited by  customers  whose  accounts  are  not  active;  they  are 
more  in  the  nature  of  reserve  deposits,  whereas  current  ac- 
counts represent  deposits  made  by  customers  mostly  in  active 
business. 

Q.  Do  you  pay  interest  on  practically  all  of  your  deposits 
and  current  accounts? 


CREDIT  LYONNAIS  511 

A.  Yes. 

Q.  Do  you  find  that  the  Bank  of  France  competes  with  you 
in  any  way? 

A.  In  no  way. 

Q.  They  receive  accounts  from  individuals  and  small  trades- 
men in  the  branches,  do  they  not? 

A.  Yes;  but  they  do  not  grant  uncovered  credits.  There 
is  no  competition  between  the  Bank  of  France  and  the  other 
banks,  because  they  do  not  do  the  same  kind  of  business.  The 
Bank  of  France  receives  deposits,  but  does  not  allow  interest 
upon  them;  it  only  discounts  bills  with  three  signatures;  it  is 
the  bankers'  bank;  it  acts  as  the  regulator  of  the  money 
market. 

Q.  Do  its  branches  receive  deposits? 

A.  Yes;  they  receive  deposits,  without  allowing  any  inter- 
est. In  times  when  money  is  cheap  the  rate  of  discount  of  the 
Bank  of  France  is  rarely  below  3  per  cent.,  and  in  the  Credit 
Lyonnais  and  other  banks  the  rate  may  be  sensibly  below  that 
of  the  Bank  of  France. 

Q.  Can  you  state  the  number  of  employes  in  the  Credit 
Lyonnais  ? 

A.  About  14,000.     It  varies  according  to  the  time  of  year. 

Q.  Are  all  of  the  important  banks  in  the  City  of  Paris 
members  of  the  clearing  house? 

A.  Yes;  about  13  of  the  most  important. 

Q.  How  frequently  are  the  clearings  made? 

A.  Three  times  a  day.  As  a  matter  of  fact,  our  clearing 
house  is  not  so  important  as  yours  in  America. 

Q.  The  clearing  houses  in  the  cities  of  France  are  in  no 
sense  a  factor;  they  are  merely  the  machinery  through  which 
the  cheques  are  cleared,  are  they  not? 

A.  To  our  knowledge  there  is  but  one  clearing  house ;  it  is 
in  Paris  and  is  merely  a  mechanism  for  settling  balances. 

Q.  Are  you  examined  at  any  time  and  in  any  way  by  the 
Government  ? 

A.  No.  The  control  of  the  Government  is  limited  to  the 
supervision  for  taxes,  to  which  every  company  is  subject. 

Q.  Your  relations  with  the  Bank  of  France  are  very  inti- 
mate and  cordial,  are  they  not  ? 


512  THE  FRENCH  BANKING  SYSTEM 

A.  Yes. 

Q.  Is  that  true  with  all  the  banks  in  France? 

A.  The  Bank  of  France  is  quite  impartial;  if  gives  no 
preference  to  any  one;  there  is  no  favoritism. 

Q.  I  understand  none  of  the  farmers  or  peasants  will  use 
cheques. 

A.  The  use  is  extremely  rare. 

Q.  How  about  your  tradesmen  all  through  the  small  towns, 
and  the  doctor  and  lawyer  and  professional  man;  would  they 
draw  the  money  out  and  pay  their  bills  in  cash? 

A.  Certainly;  most  of  them. 

Q.  When  you  establish  a  branch  in  a  small  town,  you  gen- 
erally find  a  local  independent  bank  there.  Can  this  local 
bank  compete  with  you? 

A.  There  are  certain  places  where  the  private  banks  have 
kept  on,  but  the  tendency  is  for  the  private  banker  to  disappear. 
We  take  small  sums  and  have  numerous  branches.  One  great 
distinction  is  that  the  private  bank  is  always  in  the  hands  of 
a  family.  A  man  who  originally  starts  a  private  bank  may  be 
a  good  banker,  financier,  and  business  man,  but  it  does  not 
always  follow  that  his  son,  who  in  all  likelihood  will  inherit 
the  business,  will  be  capable  of  running  it.  Our  joint-stock 
banks  do  not  go  from  father  to  son,  but  are  always  under 
efficient  management. 

Q.  What  proportion  of  your  own  payments  are  made  in 
gold? 

A.  A  very  small  proportion.     The  people  prefer  notes. 

Q.  Do  the  French  people  hoard  money  as  much  as  for- 
merly ? 

A.  No;  it  is  becoming  more  the  custom  to  put  money  in  the 
banks.  Thirty  years  ago  they  kept  the  money  at  home. 

COMPTOIR  D'ESCOMPTE 

INTERVIEW  WITH  M.  ULLMANN,  DIRECTOR  OF  THE 
COMPTOIR  D'ESCOMPTE  * 

Q.  One  of  the  things  that  we  have  in  mind  is  to  inquire  in 
regard  to  the  character  of  the  business  done  by  your  branches. 

1  Adapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 


COMPTOIR  D'ESCOMPTE  513 

A.  Yes.  We  are  especially  a  discount  bank  and  our  cus- 
tomers are  mostly  commercial  people  engaged  in  commerce 
and  industry,  so  that  our  principal  business  in  our  branch 
offices  consists  in  discounting  commercial  paper,  in  making 
advances  against  securities,  goods,  or  warehouse  receipts,  or 
sometimes  giving  blank  credits  to  our  customers  for  commer- 
cial requirements. 

O.  Have  you  stock  in  other  banks  which  you  control? 

A.  We  are  interested  in  the  Banque  de  1'Indo  Chine,  which 
is  an  issue  bank  in  the  French  colonies,  but  we  do  not  control 
it;  we  hold  a  certain  amount  of  shares. 

O.  Are  there  any  other  banks  which  you  control? 

A.  No. 

O.  You  have  not  been  in  the  habit  of  buying  up  other 
banks? 

A.  No.  The  system  here  is  to  establish  agencies  of  our 
own ;  the  Germans,  on  the  contrary,  control  other  banks  in 
order  to  arrive  at  the  same  result,  viz.,  to  get  as  much  influ- 
ence as  possible  throughout  the  country.  We  try  to  come  to 
the  same  result  by  establishing  our  own  agencies. 

Q.  Is  that  true  of  the  Credit  Lyonnais? 

A.  The  Credit  Lyonnais  and  the  Societe  Generale  have  the 
same  system. 

O.  Is  it  usual  for  large  banks  in  Paris  to  confine  their 
underwriting  operations  to  bond  syndicates? 

A.  Yes;  banks  receiving  deposits,  such  as  the  Credit  Lyon- 
nais and  the  Societe  Generale,  do  not  usually  participate  in 
syndicate  operations  covering  the  shares  of  industrial  con- 
cerns ;  other  banks,  such  as  the  Banque  de  Paris  et  des  Pays- 
Bas,  do  so,  but  they  are  not  deposit  banks.  They  have  more 
liberty  to  engage  their  own  capital  in  any  enterprise. 

Q.  You  are  not  restricted  by  law  in  doing  any  business  you 
please? 

A.  No;  it  is  only  the  custom  and  rules  of  our  society. 

O.  If  there  were  a  large  industrial  corporation  in  France 
which  wanted  to  develop  its  business  and  issue  bonds  upon  it, 

England,  Scotland,  France,  Germany,  Switzerland,  and  Italy.  Publications 
of  the  National  Monetary  Commission,  Senate  Document  No.  405,  6ist 
Congress,  2nd  Session,  pp.  249-267. 


514  THE  FRENCH  BANKING  SYSTEM 

and  if  they  were  customers  of  yours  of  unquestioned  financial 
standing,  would  you  take  their  bonds  and  sell  them? 

A.  Yes. 

Q.  But  not  their  stock  ? 

A.  If  they  were  a  well-known  concern  we  would  sell  their 
shares  too ;  we  have  done  so. 

Q.  Is  there  co-operation  between  the  large  banks  ? 

A.  We  meet  very  often  and  often  have  common  interests  in 
business. 

Q.  Do  you,  in  a  sense,  divide  the  field  ?  I  suppose  you  have 
a  certain  field  in  which  you  do  business  and  other  banks  do 
not;  Turkey,  for  instance? 

A.  Turkey  is  reserved  for  the  Banque  Ottomane. 

Q.  Take  the  electrical  business,  for  instance. 

A.  As  far  as  we  are  concerned  we  are  connected  with  the 
Thomson-Houston;  and  it  is  natural  if  the  Thomson-Houston 
and  their  friends  have  any  business  to  do,  that  they  deal 
with  us. 

Q.  There  is  nothing  in  the  law  which  restricts  you  to  any 
class  of  investment? 

A.  No. 

Q.  And  nothing  that  requires  you  to  keep  any  reserve; 
that  is,  any  amount  of  cash  as  against  your  liabilities? 

A.  No. 

Q.  Is  the  Bank  of  France  your  principal  reliance  in  case 
you  need  money  ?  Do  you  think  it  necessary  to  carry  any  ad- 
ditional reserve? 

A.  Under  our  French  system  we  consider  the  commercial 
paper  we  keep  in  the  portfolio  a  cash  reserve,  as  we  can  re- 
discount it  at  the  Bank  of  France.  We  know  the  Bank  of 
France  will  discount  these  bills  and  thus  enable  us  to  convert 
the  bills  instantly  into  cash;  this  is  the  basis  of  the  French 
banking  system. 

Q.  Outside  of  Paris  it  happens  that  you  have  branches  at 
many  of  the  same  places  as  the  Bank  of  France ;  is  there  com- 
petition between  the  branches  of  the  Bank  of  France  and 
your  own  branches? 

A.  No;  the  Bank  of  France  does  more  rediscounting  than 
discounting,  and  the  Bank  of  France  also  has  more  conserva- 


COMPTOIR  D'ESCOMPTE  5 1 5 

tive  rules  than  the  other  banks.  We  may  lend  under  the  Bank 
of  France  rate,  so  our  clients  have  an  interest  in  keeping  their 
accounts  with  us. 

Q.  You  do  not  consider  the  Bank  of  France  as  an  active 
competitor  ? 

A.  No;  competition  is  greater  with  the  Credit  Lyonnais 
and  with  the  other  private  banks  than  with  the  Bank  of 
France. 

Q.  You  do  considerable  rediscounting  of  bills,  I  take  it? 

A.  Yes. 

Q.  At  a  lower  rate  than  the  Bank  of  France? 

A.  Frequently. 

Q.  Is  the  development  of  branches  a  matter  of  recent 
times  ? 

A.  Yes ;  we  began  the  system  of  establishing  branches  about 
twenty  years  ago. 

Q.  How  many  employes  have  you  ? 

A.  Including  the  country,  something  like  5,000. 

Q.  Have  you  a  pension  system  for  your  employes  ? 

A.  Our  clerks  consent  to  a  rebate  of  5  per  cent,  on  their 
salaries,  and  we  duplicate  this  rebate  by  a  voluntary  contribu- 
tion, in  order  to  constitute  a  pension  fund ;  it  amounts  now  to 
about  7,000,000  francs. 

Q.  If  a  new  bank  were  to  be  organised  here,  would  it  be 
admitted  as  a  member  of  the  clearing  house? 

A.  Certainly. 

Q.  You  have  no  new  banks  except  the  Union  Parisienne? 

A.  There  is  also  the  Banque  Franqaise,  managed  by  M. 
Rouvier,  who  formerly  was  Premier. 

BANQUE  DE  PARIS  ET  DES  PAYS-BAS 

INTERVIEW  WITH  M.  MORET,  MANAGER  OF  THE  BANQUE 
DE  PARIS  ET  DES  PAYS-BAS  * 

Q.  We  assume  that  your  business  is  in  many  respects  quite 
unlike  that  of  the  other  joint-stock  banks? 

Adapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 
England,  Scotland,  France,  Germany.  Switzerland,  and  Italy.  Publications 
of  the  National  Monetary  Commission,  Senate  Document,  No.  405,  6ist 
Congress,  2nd  Session,  pp.  268-276. 


516  THE  FRENCH  BANKING  SYSTEM 

A.  Yes ;  in  some  respects. 

Q.  What  is  the  difference? 

A.  The  Societe  Generate,  Credit  Lyonnais,  etc.,  receive  de- 
posits from  the  public;  they  invest  these  deposits  and  try  to 
make  the  most  of  them,  paying  a  small  rate  of  interest  on 
them;  they  also  loan  money  on  commercial  paper  which  can 
be  rediscounted  at  the  Bank  of  France.  Here  we  are  more 
a  business  bank ;  we  do  not  care  for  deposits  from  the  public ; 
we  work  with  our  own  money,  with  the  money  which  is  the 
capital  of  the  bank,  and  we  are  occasionally  assisted  by  the 
capital  of  the  directors,  the  people  who  sit  around  this  table, 
who  are  all  rich  people  and  some  of  them  bankers.  As  a  rule 
we  do  not  receive  deposits  from  the  public. 

Q.  But  you  do  receive  some  deposits  ? 

A.  We  receive  the  deposits  of  big  companies  which  we  have 
created  or  promoted  or  whose  stocks  we  have  issued  —  they 
are  our  customers  —  but  we  do  not  receive  deposits  of  small 
accounts  from  the  public. 

Q.  What  is  your  capital? 

A.  75,000,000  francs. 

Q.  You  have  current  accounts —  190,000,000  francs? 

A.  They  are  current  accounts,  from  manufacturing  con- 
cerns, railway  companies,  big  organisations  of  any  kind. 

Q.  You  have  a  considerable  foreign  business? 

A.  We  have  connections  all  over  the  world,  and  very  often 
we  take  an  interest  in  business  abroad. 

Q.  Do  you  operate  more  particularly  in  one  part  of  the 
world  than  in  another? 

A.  No;  although  we  have  only  three  branches  —  one  in 
Brussels  one  in  Amsterdam,  and  one  in  Geneva. 

Q.  Do  you  endeavor  to  carry  any  special  amount  of  cash 
at  the  Bank  of  France?  Or  are  you  indifferent  as  to  the 
amount  of  balance  you  have  there? 

A.  We  always  calculate  what  sum  each  day  will  be  likely 
to  be  withdrawn  ;  besides  which  we  always  have  a  large  amount 
of  commercial  paper  which  we  could  rediscount  at  the  Bank 
of  France  at  once.  Therefore  we  keep  just  enough  cash  in 
vault  to  meet  any  cheques  which  may  be  presented. 

Q.  Do  you  carry  an  account  in  New  York? 


CREDIT  FONCIER  517 

A.  We  lend  money  to  bankers  there.  Different  kinds  of 
loans,  some  are  at  sixty  days  or  ninety  days. 

O.  You  are  not  restricted  in  any  way  as  to  the  character 
of  the  undertakings  you  may  make? 

A.  No;  \ve  can  do  as  we  like. 

Q.  Do  you  specialise  in  practice  or  do  you  consider  propo- 
sitions of  various  kinds? 

A.  All  sorts  of  propositions,  railway  building,  harbors, 
tramways,  electrical  enterprises,  etc. 

Q.  Do  you  sometimes  take  an  interest  in  business  such  as 
placing  Pennsylvania  Railroad  and  Union  Pacific  bonds  ? 

A.  Yes. 

Q.  You  frequently  act  as  managers  of  syndicates  which 
might  include  the  other  banks  of  France? 

A.  Very  often  we  take  the  head  of  syndicates. 

Q.  You  are  the  leading  bank  in  that  business  in  France? 

A.  They  say  so. 

Q.  Is  there  cordial  co-operation  between  the  banks  of  Paris 
and  the  Bank  of  France,  generally  speaking? 

A.  Yes ;  business  as  a  rule  is  done,  when  it  is  a  big  business, 
with  several  of  these  big  societies  or  banks,  and  perhaps  with 
all  of  them  together. 

Q.  Are  there  particular  corporations  in  which  you  have  a 
permanent  interest? 

A.  Yes;  so  as  to  have  some  control  in  certain  large  com- 
panies. 

Q.  What  do  you  think  of  the  attitude  of  the  Government 
toward  the  Bank  of  France?  That  is  to  say,  are  they  exact- 
ing more  and  more  from  it? 

A.  I  do  not  think  that  they  exact  too  much  from  it.  The 
shares  of  the  Bank  of  France  are  always  very  high  in  price; 
it  has  not  hurt  at  all  the  development  of  the  bank. 

CREDIT  FONCIER  DE  FRANCE 
INTERVIEW  WITH  M.  TOUCHARD,  SECRETARY  * 

Q.  Is  the  Credit  Foncier  a  public  institution  ? 

A.  Yes,  it  is  a  mixed  institution;  it  is  at  the  same  time  a 

JAdapted   from  Interviews  on   the  Banking  and  Currency  Systems  of 


518  THE  FRENCH  BANKING  SYSTEM 

joint-stock  company  and  a  society  under  the  control  of  the 
Government  by  reason  of  privileges  which  the  Government  has 
granted  to  it. 

Q.  Who  are  the  shareholders? 

A.  Any  one;  the  shares  are  dealt  in  on  the  Bourse.  The 
firm  capital  is  at  present  200,000,000  francs;  the  shares  are 
issued  at  500  francs. 

Q.  What  dividend  do  you  pay? 

A.  We  now  pay  6  per  cent;  for  several  years  it  was  only 
5  per  cent. 

Q.  Does  the  Government  receive  no  income  from  it? 

A.  No ;  on  the  contrary,  the  Government  began  by  giving 
us  a  subsidy  of  10,000,000  francs;  that  was  at  the  beginning, 
in  1852,  in  order  to  help  us  make  loans  at  a  rate  advantageous 
for  that  time.  This  subsidy  was  not  renewed,  and  the  State 
does  not  intervene  now,  except  occasionally  to  'exercise  its 
control. 

Q.  Does  the  company  appoint  the  officers  ? 

A.  The  Government  appoints  the  governor  and  the  two  sub- 
governors.  There  must  also  be  three  treasurers-general 
among  the  23  members  of  the  council  of  administration. 
These  treasurers,  as  well  as  the  other  administrators,  are 
named  by  the  general  assembly  of  stockholders ;  but  before 
presenting  their  names  to  this  assembly,  it  is  customary  to  ob- 
tain the  approval  of  the  Minister  of  Finance. 

Q.  Do  you  pay  the  same  taxes  as  the  other  banks? 

A.  Yes.  We  are  treated  like  any  ordinary  bank.  We  have 
the  special  privilege  of  issuing  bonds  secured  by  mortgages. 
It  is  a  very  complicated  system  in  France ;  there  are  legal  com- 
plications which  would  render  it  impossible  for  any  corpora- 
tion to  undertake  the  business  unless  it  had  special  privileges. 

Q.  Are  you  confined  by  law  to  business  with  mortgages? 

A.  We  have  two  principal  kinds  of  operations  —  mortgage 
loans  and  communal  loans.  The  total  business  of  the  two 
branches  of  operations  amounts  at  present  to  about  4,000,000,- 
ooo  francs.  Operations  on  so  large  a  scale  involve  a  consid- 

England,  Scotland,  France,  Germany,  Switserland,  and  Italy,  Publications 
of  the  National  Monetary  Commission,  Senate  Document,  No.  405,  6ist 
Congress,  2nd  Session,  pp.  277-291. 


CREDIT  FONC1ER  519 

erable  transfer  of  funds,  and  make  necessary  a  treasury  serv- 
ice requiring,  of  course,  the  use  of  banking  methods.  Our 
statutes,  therefore,  recognise  our  right  to  carry  on  ordinary 
banking  operations,  within  certain  rather  sharply  defined 
limits. 

Q.  How  is  your  banking  business  limited? 

A.  We  are  allowed  to  receive  deposits  up  to  a  maximum  of 
100,000,000  francs. 

Q.  Do  you  invest  in  securities  other  than  mortgages? 

A.  We  employ  our  deposit  funds  in  discounting  commercial 
bills  on  condition  that  they  have  two  signatures  and  can  be 
presented  to  the  Bank  of  France;  that  is  to  say,  they  must  not 
run  over  three  months. 

O.  You  take  mortgages  on  private  estates  ? 

A.  Our  mortgages  may  be  on  houses  or  on  rural  property. 

Q.  What  is  the  precise  relationship  of  the  stockholders  to 
the  business  of  the  company?  Have  they  really  a  voice  in  the 
administration? 

A.  The  two  hundred  largest  stockholders  meet  once  a  year 
to  ratify  accounts,  vote  the  dividend,  and  consider  the  ques- 
tions docketed  for  the  day  of  the  meeting. 

Q.  What  is  the  usual  length  of  time  for  mortgages  on  real 
estate  ? 

A.  Our  statutes  allow  us  to  loan  for  seventy-five  years  on 
ordinary  rural  or  city  property.  In  the  case  of  summer  resorts 
and  certain  other  property  liable  to  depreciate  rapidly,  for  the 
sake  of  prudence  we  do  not  generally  lend  for  more  than  thirty 
years;  besides,  the  borrowers  always  have  the  right  to  repay 
at  any  time,  and  they  often  avail  themselves  of  this  right,  so 
that  the  average  length  of  our  loans  is  much  less  —  hardly 
exceeding  fifteen  or  twenty  years. 

Q.  What  is  the  cost  for  amortisation  in  the  long  mortgages 
on  property  in  the  country? 

A.  The  amortisation  is  spread  over  the  whole  duration  of 
the  loan,  so  that  the  total  of  the  interest  paid  and  the  capital 
reimbursed  forms  a  constant  yearly  annuity. 

Q.  Do  you  employ  your  amortisation  funds  to  buy  new 
mortgages  ? 

A.  Yes ;  we  lend  again. 


520  THE  FRENCH  BANKING  SYSTEM 

Q.  May  you  call  your  bonds  at  par?  Are  they  payable  at 
par  at  your  option? 

A.  In  our  recent  issue  we  have  put  that  clause  in,  viz.,  that 
we  can  redeem  our  bonds  at  par.  Generally  we  only  redeem 
a  certain  portion  of  them  each  year,  which  are  drawn  by  lot- 
tery. 

Q.  What  is  the  minimum  size  of  your  mortgages  on  private 
estates  ? 

A.  There  is  no  minimum ;  but  we  do  not  care  to  make  very 
small  loans  because  it  costs  too  much  to  foreclose. 

Q.  What  percentage  of  your  total  business  is  in  the  country 
and  what  in  the  city? 

A.  About  one-half  in  Paris,  and  our  best  business  is  in  Paris. 
The  urban  mortgages  cause  us  less  difficulty,  and  the  tendency 
is  for  the  proportion  of  them  to  increase. 

Q.  Who  are  the  subscribers  to  the  bonds,  and  what  are  the 
usual  sums  subscribed?  Are  they  small  or  large? 

A.  They  are  bought  by  small  people,  and  generally  remain 
in  the  hands  of  persons  of  small  capital.  This  is  one  of  the 
reasons  why  their  quotations  show  so  little  fluctuation. 

Q.  Do  you  lend  on  farms  ? 

A.  Yes.  Up  to  one-half,  except  on  forest  land,  vineyards, 
and  the  like,  on  which  we  lend  only  one-third.  We  do  not 
lend  on  mines.  On  factory  buildings  we  lend  only  on  the 
value  of  the  ground  and  of  the  building,  independently  of  its 
industrial  value. 

Q.  What  other  institutions  of  this  character  are  there  in 
France  ? 

A.  There  are  no  others ;  we  no  longer  have  a  legal  monop- 
oly, but  we  very  nearly  have  a  practical  monopoly.  There  are 
private  individuals  who  make  mortgage  loans,  but  no  large 
company  makes  this  the  principal  feature  of  its  business. 

Q.  How  long  has  it  been  the  privilege  of  the  Credit  Foncier 
to  add  lotteries  to  its  loans? 

A.  It  has  done  so  from  the  beginning,  although  we  are 
obliged  to  ask  the  permission  of  the  Minister,  but  it  is  on  that 
account  that  we  have  been  able  to  place  our  bonds  so  low. 


521 


CAISSE  DES  DEPOTS  ET  CONSIGNATIONS 


INTERVIEW    WITH    M.    DELATOUR,    GENERAL   DIRECTOR    OF 
THE  CAISSE  DES  DEPOTS  ET  CONSIGNATIONS  1 

Q.  We  should  like  to  know  the  general  character  of  the 
business  conducted  by  your  institution. 

A.  The  mission  of  the  Caisse  des  Depots  et  Consignations 
is  to  receive,  hold,  and  repay  all  private  funds  intrusted  to  the 
State  either  voluntarily  or  under  compulsion. 

Q.  You  say  that  you  also  do  an  insurance  business.  What 
do  you  mean  by  that? 

A.  The  insurance  office,  managed  by  the  Caisse,  issues  poli- 
cies of  life  insurance,  insurance  payable  after  death  or  in  case 
of  accident,  like  any  private  insurance  company.  As  regards 
accidents  to  employes  while  at  work,  it  insures  only  against 
such  accidents  as  cause  death  or  permanent  total  or  partial 
incapacity  for  work. 

Q.  Is  this  a  corporation? 

A.  The  Caisse  des  Depots  et  Consignations  is  not  a  corpora- 
tion. It  is  a  state  organism,  but,  while  charging  the  Caisse 
with  the  management  of  all  private  funds,  which  may  be  turned 
over  to  it  by  the  State  under  different  headings,  the  legislature 
bestows  upon  it  full  autonomy,  in  order  to  avoid  even  a  sem- 
blance of  possible  confusion  in  the  handling  of  private  moneys 
with  the  handling  of  public  moneys.  Moreover,  it  has  placed 
the  Caisse  under  the  direct  supervision  and  the  guaranty  of  the 
legislative  powers. 

Q.  What  is  done  with  the  profits  realised  from  the  busi- 
ness? 

A.  Profits  earned  by  the  Caisse  on  deposits  of  the  savings 
banks  are  turned  over  to  the  reserve  and  guaranty  fund  of 
savings  banks. 

Q.  What  restrictions  govern  the  investment  of  your  funds? 

A.  As  long-term  investments,  we  make  loans  to  departments 
and  municipalities,  sometimes  to  the  State;  we  take  govern- 

iAdapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 
England,  Scotland,  France,  Germany,  Su'itzerland.  and  Italy,  Publications 
of  the  National  Monetary  Commission,  Senate  Document,  No.  405,  6ist 
Congress,  2nd  Session,  pp.  296-308. 


522  THE  FRENCH  BANKING  SYSTEM 

ment  rentes,  treasury  securities,  guaranteed  railroad  bonds,  etc. 
As  short-term  investments,  we  take  treasury  bonds,  bonds  of 
the  Monte  de  Piete  of  Paris  (municipal  pawnshop),  etc.  Fin- 
ally, we  keep  large  sums  in  cash,  either  in  our  own  vaults  or 
to  our  credit  in  the  treasury  and  the  Bank  of  France,  which, 
for  that  purpose,  keep  account  currents  on  demand  for  us. 

Q.  You  do  not,  as  a  rule,  invest  in  mortgages  ? 

A.  No;  owing  to  the  difficulty  in  disposing  of  such  invest- 
ments. 

Q.  You  purchase  no  bills  and  do  no  commercial  business 
whatever  ? 

A.  No;  that  role  is  played  by  the  Bank  of  France.  Some- 
times we  make  advances  on  securities,  but  only  on  treasury 
bonds. 

Q.  Your  organisation  is  quite  unique  in  the  world,  is  it  not? 

A.  There  is  nothing  like  it  in  England  or  America,  but 
there  are  similar  institutions  in  Belgium  and  Italy,  for  in- 
stance. In  France  this  institution  is  highly  appreciated  by  the 
lawmakers,  who  steadily  increase  its  functions,  and  the  number 
of  laws  and  regulations  governing  the  Caisse  is  ever  growing. 

Q.  It  is  customary  in  France  for  savings  banks  to  carry 
their  reserve  with  this  establishment? 

A.  The  savings  banks  are  bound  to  turn  over  to  us  all  they 
receive  from  their  depositors,  except  such  sums  as  may  be  re- 
quired to  meet  immediate  demands. 

Q.  Then,  as  a  matter  of  fact,  this  is  a  central  bank  for  the 
savings  banks  of  France? 

A.  Precisely. 

CREDIT  AGRICOLE 

INTERVIEW  WITH  M.  DECHARME,  CHEF  DU  SERVICE  DU 
CREDIT  MUTUEL  ET  DE  LA  COOPERATION  AGRICOLE 

AT   THE   MINISTERS  DE   L' AGRICULTURE  l 

Q.  What  is  the  nature  of  the  business  of  the  Credit  Agricole 
and  when  was  it  instituted? 

1Adapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 
England,  Scotland,  France,  Germany,  Switzerland,  and  Italy,  Publications 
of  the  National  Monetary  Commission,  Senate  Document,  No.  405,  6ist 
Congress,  2nd  Session,  pp.  309-322. 


CREDIT  AGRICOLE  523 

A.  The  first  law  was  in  1899.  The  first  bank  was  opened 
in  1900.  The  Credit  Agricole  is  based  upon  local  organisa- 
tions. France  is  divided  into  86  departments,  in  each  of  which 
we  are  to  have  a  regional  bank  (caisse  regionale);  and  we 
hope  eventually  to  have  a  local  office  (caisse  locale)  in  each 
commune  of  each  department.  Among  these  36,000  com- 
munes there  are  many  which  are  cities,  which  naturally  would 
not  have  agricultural  banks.  There  are  only  2  out  of  the  86 
departments  in  France  which  have  not  already  established  a 
regional  bank. 

Q.  Who  furnishes  the  capital? 

A.  The  basis  of  the  system  is  the  local  office  of  the  Credit 
Agricole  in  which  each  member  —  local  farmers  —  has  one  or 
many  shares  of  20  francs,  but  on  which  he  has  to  pay  only 
5  francs  down.  On  payment  of  these  5  francs  he  becomes  a 
stockholder.  When  a  local  office  has  been  established  it  turns 
all  of  its  capital  over  to  the  regional  office.  Then  comes  the 
State  which  advances  to  the  regional  bank  an  amount  four 
times  the  capital  which  has  been  subscribed  by  the  local  banks. 
The  money  given  by  the  Government  is  not  really  given ;  it  is 
lent  without  charge,  without  interest. 

Q.  For  what  purposes  can  this  capital  be  used? 

A.  The  regional  office  does  not  lend  directly  to  the  farmers ; 
it  lends  to  the  local  office,  and  the  local  office  has  a  board  of 
directors  which  examines  the  demands  of  the  various  mem- 
bers. 

Q.  Under  what  conditions  do  they  make  loans  to  farmers, 
and  are  their  loans  confined  entirely  to  people  engaged  in  agri- 
culture ? 

A.  The  State  loans  to  the  regional  office  without  interest; 
the  regional  office  loans  to  the  local  office  at  3  per  cent. ;  the 
local  office  loans  to  the  farmers  at  between  3^  and  4  per  cent. ; 
in  the  northern  region  at  3/2  per  cent. ;  in  the  southern  at  4 
per  cent. 

Q.  Under  what  conditions? 

A.  The  farmer  who  wants  to  borrow  from  the  local  office 
draws  a  bill  upon  himself,  takes  it  to  the  local  office,  and  the 
board  of  administration  there  considers  it.  If  they  approve 
it,  the  president  signs  it  —  and  it  has  then  two  signatures  — 


524  THE  FRENCH  BANKING  SYSTEM 

and  then  sends  it  to  the  regional  office;  if  the  regional  office 
has  plenty  of  money  they  will  lend  the  money  directly;  if  not, 
the  president  of  the  regional  office  signs  it  —  it  has  then  three 
signatures  and  is  bankable  paper  —  and  it  is  taken  to  the  Bank 
of  France.  During  the  crisis  in  the  south  of  France  last  year 
in  the  wine-growing  region  at  Montpellier,  the  centre,  the 
regional  office  had  one  million  capital ;  the  Government  then 
added  4;  that  made  5,  but  they  lent  at  that  office  all  together 
1 6  millions,  and  the  difference  was  obtained  from  the  Bank  of 
France  in  the  way  described  by  using  paper  with  three  signa- 
tures. Before  the  founding  of  these  agricultural  societies  it 
would  have  been  difficult  for  a  farmer  to  obtain  the  three  sig- 
natures necessary  to  borrow  from  the  Bank  of  France,  and 
what  happened  last  year  in  the  south  of  France  could  not  have 
occurred  before  the  organisation  of  the  Credit  Agricole.  It 
should  be  added  there  has  never  been  one  cent  lost  by  the  Credit 
Agricole. 

Q.  Are  all  loans  made  to  members  ? 

A.  Yes;  exclusively  to  members. 

Q.  Who  can  become  a  member? 

A.  Farmers;  agricultural  workmen  are  excluded.  We  do 
not  lend  to  people  for  nourishment  to  support  themselves. 
We  lend  them  money  to  increase  the  production  of  the  land. 

Q.  Must  a  man  have  some  share  in  the  crops? 

A.  We  lend  money  to  buy  a  horse,  a  cow,  or  to  buy  fertil- 
izer. We  will  lend  to  a  man  who  rents  a  farm,  but  does  not 
own  it,  to  buy  machinery,  cattle,  etc.,  but  we  will  not  lend  to  a 
man  who  wants  to  borrow  the  money  for  his  own  consumption ; 
we  do  not  lend  money  for  a  man  to  buy  a  coat,  for  instance. 
These  local  offices  are  in  communities  where  everybody  knows 
everybody  else,  and  they  always  ask  what  the  man  wants  to 
borrow  for,  and  if  he  says  he  wants  400  francs  to  buy  a  cow, 
they  watch  him,  and  if  four  or  five  days  afterwards  he  has  no 
cow.  they  know  it.  As  the  liability  is  without  limit,  the  other 
members  of  the  locality  would  be  responsible.  At  the  begin- 
ning the  farmers  were  afraid  of  unlimited  liability,  and  on  that 
account  they  had  to  make  it  limited,  but  now,  in  all  of  the  new 
offices,  the  responsibility  is  unlimited. 

Q.  What  are  your  co-operative  societies  ? 


CREDIT  AGRICOLE  525 

A.  They  are  societies  for  the  production,  preservation,  sale, 
or  transformation  of  agricultural  products.  There  are  co- 
operative agricultural  societies  in  the  wine-growing  regions 
which  have  their  own  wine  cellar ;  there  are  co-operative  dairy 
societies  for  making  butter  and  cheese ;  there  are  also  co-opera- 
tive societies  which  use  waterfalls  and  electricity ;  co-operative 
mills  to  grind  corn;  co-operative  railways  to  bring  beet  roots 
to  the  sugar  refinery;  co-operative  distilleries  and  co-opera- 
tive warehouses  for  corn.  To  these  co-operative  societies  we 
make  loans  for  twenty-five  years.  The  Government  loans 
without  charge  to  the  regional  office  and  the  regional  office 
lends  to  these  co-operative  societies  for  twenty-five  years  at 
2  per  cent. 

Q.  What  is  the  security? 

A.  The  guarantee  is  the  consolidated  liability  of  all  of  the 
members  of  these  co-operative  societies  and  also  a  mortgage 
upon  their  real  estate ;  their  responsibility  is  absolutely  without 
limit. 

Q.  Do  you  compete  at  all  with  the  branches  of  the  other 
banks  or  with  the  Bank  of  France? 

A.  No;  we  have  an  entirely  different  class  of  customers. 

Q.  Is  there  any  other  institution  of  this  character  in  France, 
or  do  you  practically  cover  the  field? 

A.  The  members  of  these  local  offices  are  people  who  up  to 
the  time  these  local  offices  were  organised  had  never  had  any 
banking  connection  at  all.  The  only  persons  with  whom  the 
local  orifices  compete  are  individuals  who  used  to  loan  to 
farmers  at  very  high  rates  of  interest. 


CHAPTER  XXV 
THE  GERMAN  BANKING  SYSTEM 

BANKING  ARRANGEMENTS  IN  GERMANY 

1  VARIOUS  systems  can  be  adopted  in  the  banking  profession 
for  the  transaction  of  business.  The  most  lucrative  method, 
at  all  events  the  one  in  which  the  power  of  large  capital  is  most 
effectively  turned  to  account,  is  that  of  the  Rothschild  firms, 
whose  example  was  followed  by  many  large  private  concerns 
at  home  and  abroad.  These  firms  avoid  troublesome  current 
business,  maintain  only  a  fewr  connections,  and  concentrate 
their  whole  energies  on  isolated  but  important  ventures  and 
undertakings  in  which,  owing  to  the  large  amount  of  means 
immediately  required,  no  competition  worth  mentioning  ex- 
isted before  the  growth  of  capable  joint-stock  banks.  Up  to 
the  middle  of  last  century  these  firms  actually  possessed  a  mo- 
nopoly so  far  as  the  loan  issues  of  most  European  States  were 
concerned,  and  they  earned  enormous  profits  according  to 
present-day  ideas.  In  the  course  of  the  last  decades,  how- 
ever, this  monopoly  has  been  done  away  with  so  far  as  Euro- 
pean States  are  concerned  and  only  prevails  to  a  limited 
extent  in  some  foreign  countries.  Since  that  time  the  Roths- 
childs have  devoted  themselves  to  several  large  industrial  en- 
terprises, such  as  the  Russian  naphtha  industry,  the  Spanish 
copper  and  quicksilver  mines,  etc. 

Another  system  consists  in  the  division  of  work  and  special- 
isation, customary  in  England,  but  which  has  been  frequently 
abandoned  of  late.  In  England  the  issuing  and  syndicate 
business  is  carried  on  by  special  houses  which,  like  Roths- 

1  Adapted  from  Geh.  Oberfinanzrat  Waldemar  Mueller,  The  Organiza- 
tion of  Credit  and  Ranking  Arrangements  in  Germany;  Max  Wittner  and 
Siegfried  Wolff,  The  Method  of  Payment  by  means  of  Bank-Account 
Transfers  and  the  Use  of  Checks  in  Germany.  Publications  of  the  National 
Monetary  Commission,  Senate  Document  No.  508,  6ist  Congress,  2nd 
Session,  pp.  117-271. 


BANKING  ARRANGEMENTS  527 

child,  do  not  call  themselves  bankers,  but  merchants.  Brokers 
and  jobbers  carry  on  stock  broking  on  the  stock  exchange  and 
in  the  open  market,  the  former  (theoretically  at  least)  on  ac- 
count of  third  persons  and  the  latter  on  their  own  account. 
It  is  the  exclusive  business  of  other  firms  to  place  credit  at 
the  disposal  of  home  and  foreign  firms  by  giving  acceptance 
to  bills.  These  firms,  strange  to  say,  are  mostly  of  German 
origin  (Friihling  &  Goschen,  Frederik  Huth  &  Co.,  Klein- 
wort  &  Sons,  etc.),  and  carry  on  business  in  such  a  reliable 
manner  that  they  are  allowed  to  enter  into  bill  obligations 
amounting  to  more  than  five  times  their  estimated  means. 
The  clearing  and  deposit  banks  manage  moneys  on  account 
of  third  parties. 

It  must  be  noted  that  the  division  of  labour  and  its  opera- 
tion are  based  on  free  business  practice  in  England  without  any 
legal  compulsion.  Consequently,  no  opposition  is  offered  in 
that  country  to  the  different  methods  of  carrying  on  business 
employed  by  the  so-called  foreign  banks,  i.  e.,  the  numerous 
branches  of  continental  banks,  including  the  branch  offices 
of  the  Deutsche  Bank,  the  Dresdner  Bank,  and  the  Disconto- 
Gesellschaft,  despite  the  fact  that  their  competition  is  un- 
pleasant for  the  English  institutions.  In  Germany,  in  conse- 
quence of  business  requirements  and  also  of  the  small  amount 
of  capital  in  the  country  at  the  beginning  of  its  modern  eco- 
nomic development,  the  peculiar  system  has  developed  that 
credit  banks  combine  all  kinds  of  financial  business  (generally 
with  the  sole  exception  of  mortgage-credit  transactions),  so 
that  every  customer  can  settle  all  his  financial  affairs  in  one 
spot  on  comparatively  the  cheapest  terms  possible. 

Account-current  transactions  form  the  fundamental  branch 
of  business.  The  bank  undertakes  all  the  financial  business 
of  its  client  in  return  for  a  moderate  commission  on  the  turn- 
over calculated  on  that  side  of  the  account  which  happens  to 
be  the  greater,  makes  and  receives  payments,  collects  bills, 
checks,  and  other  documents,  and  pays,  or  charges,  interest  on 
the  balance,  generally  at  i  per  cent,  below  the  Reichsbank  dis- 
count rate  for  credit  balances  and  T  per  cent,  above  the  Reichs- 
bank discount  rate  for  balances  debited.  The  bank  discounts 
the  bills  received  by  its  customers,  special  arrangements  being 


528  THE  GERMAN  BANKING  SYSTEM 

made  as  to  the  limit  of  the  amount  and  terms,  according  to 
the  quality  of  the  bill,  *.  e.,  according  to  the  trustworthiness 
of  the  other  persons  figuring  on  it.  Should  a  customer  re- 
quire foreign  bills  to  settle  his  liabilities  abroad,  i.  e.,  checks 
or  bills  payable  in  the  country  concerned,  the  bank  provides 
them  from  its  own  stock  or  draws  bills  or  checks  to  the  amount 
desired  on  its  agents  or  correspondents  in  the  country  in  ques- 
tion. 

Should  the  debit  balance  not  be  a  merely  temporary  one, 
or  one  soon  covered  by  fresh  receipts,  the  granting  of  special 
credit  is  necessary,  and  arrangements  have  to  be  made  as  to 
the  amount  and  conditions  of  the  same.  Such  credit  is  either 
covered  or  uncovered  credit.  The  cover  consists  principally 
of  current  securities  with  a  margin  against  fluctuations  ac- 
cording to  the  nature  of  the  security,  and  which  is  higher  for 
shares  than  for  securities  bearing  a  fixed  rate  of  interest. 
Uncovered  credit  is  only  granted  in  exceptional  cases  to  others 
than  business  men  —  as  a  rule  only  to  first-class  mercantile 
firms  of  repute,  whose  affairs  are  in  strict  order. 

Bankers  and  other  firms  with  large  cash  transactions  keep 
a  so-called  "  cheque "  account  at  their  bank  in  addition  to 
the  chief  account,  in  which  no  debit  balances  may  occur;  no 
interest  is  paid  on  the  amount  deposited,  which  is  always  kept 
in  suitable  proportion  to  the  payments  made,  but,  on  the  other 
hand,  no  turnover  commission  is  charged. 

Those  customers  are  appreciated  most  who  claim  credit 
during  their  buying  seasons,  but  who  not  only  pay  back  the 
borrowed  money  during  their  selling  season,  but  who  have 
balances  to  their  credit.  This  is  the  case  with  a  great  num- 
ber of  commercial  firms  and  in  many  branches  of  industry, 
more  especially  in  Berlin.  The  seasons  in  different  branches 
occurring  at  different  times  of  the  year,  it  follows  that  a  large 
bank,  with  branches  and  connections  in  all  industrial  parts  of 
Germany,  has  the  advantage  of  a  suitable  distribution  of 
accounts  among  all  branches  of  trade,  etc.,  and  the  best  pos- 
sible adjustment  of  its  debit  and  credit  arrangements. 

The  debtors  in  a  bank's  balance  sheet  comprise  not  only 
those  who  have  received  advances  of  ready  money  but  also 
those  to  whom  the  bank  has  granted  credit  by  bill  accept- 


BANKING  ARRANGEMENTS  529 

ance ;  the  bill  drawn  by  the  debtor  and  accepted  by  the  bank 
is  discounted  elsewhere.  It  is  the  duty  of  the  drawer  of  the 
bill  to  cover  it  before  it  matures,  and  when  the  bill  is  accepted 
he  is  booked  simultaneously  as  a  debtor  to  the  bank  under 
the  date  of  maturity. 

Whether  the  general  public  will  make  an  extensive  use  of 
checks  is  doubtful.  In  England  the  conditions  necessary  for 
check  transactions  exist,  as  every  one  has  a  banking  account, 
and  all  payments  to  be  made  or  received  are  effected  through 
the  banks.  To  Germans  this  seems  very  strange ;  a  large  part 
of  the  public  cannot  keep  a  banking  account,  and  when  it  is 
in  a  position  to  do  so  either  expects  high  rates  of  interest  or 
keeps  no  permanent  balances  and  pays  no  commissions.  Un- 
der such  circumstances  there  is  no  sense,  from  a  business  point 
of  view,  in  the  shoemaker,  who  has  no  banking  account, 
accepting  a  check,  which  he  has  to  cash,  instead  of  ready 
money;  for  the  shoemaker  has  to  take  an  unprofitable  walk, 
and  the  bank  has  to  examine  the  check,  pay  and  book  it,  and 
in  some  cases  notify  by  letter  the  customer  of  its  payment. 
The  ingenuous  idea  prevails  that  by  some  cabalistic  method 
of  procedure  the  bank  earns  something  by  such  transactions 
that  in  reality  only  cause  irksome  work. 

The  Reichsbank,  with  a  creative  and  organising  spirit,  laid 
the  foundations  of  the  system  of  payments  by  means  of  trans- 
fers to,  and  deductions  from  accounts  current  that  obtains 
in  Germany,  the  so-called  "  giro  system.1  It  was  in  every 
way  preordained  for  this  creative  work,  for  at  the  time  of  its 

xln  order  to  facilitate  its  giro  business  and  reduce  the  friction  to  a 
minimum,  the  Reichsbank  has  special  printed  forms  prepared  for  the 
various  kinds  of  transactions,  the  use  of  which  is  made  compulsory  on 
the  public.  For  a  simple  transfer  of  money  from  one  customer  to 
another,  whether  they  be  in  the  same  town  or  in  different  places,  the 
"  red  check "  is  employed,  which  is  filled  out  by  the  party  making  the 
transfer  and  handed  in  to  the  bank.  It  is  not  a  check  in  the  proper  sense 
of  the  term,  but  is  so  called  because  the  printed  forms  resemble  checks 
and  are  put  up  in  books  in  the  same  way  as  checks.  The  word  "  check  " 
does  not  occur  in  the  printed  matter  of  the  blank ;  neither  is  the  instru- 
ment transferable.  When  a  number  of  payments  are  made  simultaneously 
the  party  making  the  transfers  is  furnished  with  a  blanket  form  on  which 
the  names  of  the  individual  firms  and  the  various  sums  are  entered  and 
which  has  to  be  accompanied  by  a  red  check  covering  the  aggregate 
amount.  For  the  so-called  "  great  banks  "  of  Berlin,  some  of  which  have 
a  volume  of  transfer  transactions  amounting  to  as  much  as  one  hundred 
transfers  for  each  bank  per  diem,  there  are  blanket  forms  which  are  of 


530  THE  GERMAN  BANKING  SYSTEM 

foundation  it  was  the  only  financial  institution  whose  activities 
extended  over  the  whole  Empire,  while  in  the  territorially 
restricted  and  immature  banking  systems  of  those  days  the 
conditions  were  lacking  for  the  development  either  of  a  giro 
business  or  of  a  system  of  payments  by  means  of  checks.  In 
the  giro  system,  with  its  splendid  organisation,  the  Reichsbank 
has  created  an  institution  that  has  given  the  German  system 
of  payments  its  characteristic  stamp,  just  as  the  apparatus  of 
checks  and  clearing  houses  has  imparted  a  typical  character 
to  the  system  of  payments  in  other  countries,  like  England 
and  the  United  States.  The  giro  business  in  Germany,  how- 
ever, is  far  from  having  attained  the  dimensions  that  the  use 
of  checks  has  in  England  and  America. 

The  number  of  long-distance  transfers  is  about  double  that 
of  the  locals.  This  is  as  it  should  be,  as  it  is  mainly  in  the 
matter  of  long-distance  transfers  that  the  giro  system  has  the 
advantage  over  the  method  of  payment  by  check.  In  the  mat- 
ter of  local  transfers,  on  the  other  hand,  giro  and  check  are 
probably  about  on  a  level  with  respect  to  the  number  of  trans- 
actions. 

To  prevent  themselves  from  being  ruined  by  the  competi- 
tion of  the  Reichsbank,  the  private  banks  of  issue  x  have  been 
obliged  to  offer  various  inducements  to  their  customers  in  the 
matter  of  the  giro  business.  They  make  no  demands  in  re- 
gard to  a  minimum  balance,  pay  interest  on  deposits,  do  not 
oblige  their  customers  to  domicile  bills  drawn  on  them  at  the 
bank,  and  exact  no  charge  from  persons  having  no  account 
with  them  who  desire  to  have  sums  placed  to  the  account  of 
depositors  (to  some  extent  also  making  cash  payments  free 
to  third  parties  who  are  non-depositors  for  account  of  de- 
positors). The  private  banks  of  issue  sustained  a  severe  blow 
in  1900  on  the  occasion  of  the  renewal  of  the  bank  laws 

a  different  colour  for  each  bank.  When  cash  is  wanted  the  so-called 
"  white  check "  is  employed.  This  is  a  legally  constituted  check.  There 
are  special  printed  forms  for  the  use  of  those  who  have  no  account  with 
the  Reichsbank. 

1  Banks  of  issue  were  formerly  numerous  in  Germany.  Gradually,  how- 
ever, nearly  all  of  them  renounced  the  privilege  of  issue,  as  the  laws  re- 
lating to  banking  made  their  existence  as  banks  of  issue  more  and  more 
difficult.  At  the  present  time  there  are  only  4  such  banks  besides  the 
Reichsbank,  viz. :  the  Bayerische  Notenbank,  the  \Vurttembergische  Noten- 
bank,  the  Sachsische  Bank,  and  the  Badische  Bank. 


BANKING  ARRANGEMENTS  531 

through  the  provision  prohibiting  them  from  discounting  bills 
at  a  lower  rate  than  the  Reichsbank  whenever  its  rate  reaches 
or  exceeds  4  per  cent,  and  not  allowing  them  to  go  more  than 
one-fourth  of  i  per  cent,  below  the  official  rate  and  one-eighth 
of  i  per  cent,  below  whatever  private  rate  the  Reichsbank  may 
have  whenever  the  bank  rate  is  below  4  per  cent.  These  tram- 
mels imposed  upon  the  principal  business  of  the  banks  was 
bound  to  affect  their  giro  business  injuriously  in  spite  of  the 
efforts  made  to  counteract  the  mischief  by  the  establishment 
(especially  in  Wiirttemberg )  of  many  new  branches  and  agen- 
cies. These  banks  of  issue  have  never  had  any  great  im- 
portance as  regards  the  giro  business,  and  even  at  the  present 
day  the  volume  of  their  transactions  is  relatively  insignificant. 

The  post-check  system  supplements  in  a  most  effective  man- 
ner the  gfro  system  of  the  Reichsbank  in  that  it  brings  in 
connection  with  the  five  hundred  establishments  (more  or  less) 
of  the  Reichsbank  about  39,000  post-offices  and  post  agencies. 
As  all  the  post  stations  are  included  in  the  post-check  system, 
the  Reichsbank's  network  of  branches  is  spread  out  uniformly 
in  a  compact  manner  over  the  whole  Empire. 

The  post-check  system,  inaugurated  January  i,  1909,  would 
more  appropriately  be  termed  the  post  giro  system.  For  at 
bottom  its  purpose  is  to  become  a  giro  system,  a  system  of 
monetary  transfers  by  means  of  assignments  to,  and  deduc- 
tions from  accounts  current.  What  it  is  aiming  at  is  to  make 
it  unnecessary  for  German  letter  carriers  to  be  lugging  around 
millions  in  cash  every  day.  The  money  sent  through  the 
German  post-office  in  1907  amounted  to  no  less  than  13  1/3 
billion  marks.  The  post-check  system  has  this  in  common  with 
the  giro  system  of  the  Reichsbank  that  it  extends  over  the 
whole  length  and  breadth  of  the  German  Empire,  while  the 
activity  of  all  other  institutions  carrying  on  a  system  of  giro, 
as  well  as  check,  payments,  with  the  exception  of  the  union 
of  the  Schulze-Delitzsch  credit  associations,  is  territorially  or 
locally  restricted.  The  giro  network  and  that  of  the  post- 
check  system  are  connected  with  each  other  by  certain  chan- 
nels that  render  it  possible  for  payments  to  travel  unhindered 
from  the  one  system  over  to  the  other  without  the  intervention 
of  cash. 


532  THE  GERMAN  BANKING  SYSTEM 


GENERAL  SKETCH  OF  BANK  AND  CREDIT  ORGANISATION 
IN  GERMANY 

1  Germany  witnessed  a  tremendous  economic  expansion  dur- 
ing the  twenty-year  period  1888—1907.  There  occurred  a 
considerable  increase  and  extensive  circulation  of  capital. 
This  movement  of  capital  naturally  passes  through  the  banks 
and  is  brought  about  by  them.  As  collectors  and  distributors 
of  capital,  the  banks  are,  so  to  speak,  the  focal  points  of  eco- 
nomic life. 

We  are  here  concerned  with  three  kinds  of  credit  institu- 
tions —  the  note  banks  (banks  of  issue),  the  credit  banks,  and 
the  land  credit  institutions  (mortgage  banks  and  land  mortgage 
associations). 

BANKS  OF  ISSUE 

The  present  organisation  of  the  note-bank  system  is  based 
on  the  bank  act  of  March  14,  1875,  and  the  supplement  to  this 
act  of  June  7,  1899.  Even  previous  to  the  founding  of  the 
German  Empire  the  greater  part  of  Germany  had  become 
united  commercially  through  the  formation  of  the  Customs 
Union  (Zollverein).  Similar  further  movements  toward  union, 
however,  had  met  with  but  little  success  in  the  domain  of 
currency  and  with  none  whatever  in  that  of  banking.  In  the 
newly  founded  German  Empire  seven  different  monetary  sys- 
tems were  in  existence,  and  as  all  German  States,  with  the 
exception  of  the  free  city  of  Bremen,  were  on  a  silver  basis, 
there  was  above  all  a  great  want  of  a  well  regulated  and  ade- 
quate circulation  of  gold  coin.  The  prevalence  of  paper  cir- 
culation was  felt  in  the  most  annoying  manner. 

Thirty-two  banks  had  the  right  to  issue  notes,  and  in  the 
absence  of  adequate  legislation,  it  was  found  on  many  occa- 
sions that  the  notes  issued  were  not  sufficiently  secured. 

The  first  step  which  the  Government  took  to  improve  these 
conditions  was  the  act  of  December  4,  1871,  concerning  the 

1  Adapted  from  Robert  Franz,  The  Statistical  History  of  the  German 
Banking  System.  1888-1907,  Publications  of  the  National  Monetary  Com- 
mission, Senate  Document  No.  508,  6ist  Congress,  2nd  Session,  pp.  7-115. 


COMMERCIAL  BANKS  533 

coining  of  imperial  gold  pieces.  The  coinage  act  of  July  9, 
1873,  which  proclaimed  the  gold  standard  for  the  Empire, 
formally  completed  the  organisation  of  the  German  currency 
system.  It  was  recognised  more  and  more  that,  in  order  to 
give  effect  to  the  gold  standard,  which  for  the  time  being  ex- 
isted merely  on  paper,  and  in  order  to  regulate  and  supervise 
the  entire  currency  circulation,  the  establishment  of  a  central 
bank  was  an  absolute  necessity.  This  consideration  finally  led 
to  the  establishment  of  the  German  Reichsbank,  which  came 
into  being  on  January  i,  1876,  absorbing  at  the  same  time  the 
Bank  of  Prussia  (note  bank). 

The  predominance  of  the  Reichsbank  over  the  private  note 
banks  was  secured  through  its  considerably  larger  capital,  fur- 
ther through  the  volume  of  its  tax-free  note  contingent,  which 
exceeded  considerably  the  amount  of  all  the  other  contingents, 
and  which  subsequently  was  to  increase  still  more  through  the 
accretion  of  the  contingents  of  the  note  banks  which  might 
renounce  their  rights  of  issue. 


The  close  relation  of  the  so-called  regular  banking  business 
to  that  of  the  floating  of  enterprises,  the  trading  in  and  the  is- 
sue of  shares  is  typical  of  the  organisation  of  the  German 
credit-bank  system.  The  development  of  the  railroad  system 
beginning  about  the  middle  of  the  last  century,  which  caused 
a  considerable  demand  for  and  circulation  of  capital,  and  the 
greater  extension  of  state  credit,  induced  the  banks  to  turn 
to  the  flotation  and  issue  business. 

The  period  following  the  founding  of  the  German  Empire, 
as  mentioned  before,  witnessed  a  vigorous  development  of 
German  industry,  especially  of  the  mining  and  (beginning 
with  the  nineties)  of  the  electrical  industries,  which  required 
a  continuous  inflow  of  new  capital.  At  the  same  time  Ger- 
man foreign  commerce,  particularly  with  oversea  countries, 
kept  on  steadily  increasing.  Under  such  conditions  the  eco- 
nomic policy  of  the  banks  of  placing  the  funds  entrusted  to 
them  at  the  service  of  the  new  development  must  be  regarded 
as  perfectly  proper.  The  banks  furthered  this  development 


534  THE  GERMAN  BANKING  SYSTEM 

by  forming  stock  companies,  granting  long-term  credit,  as- 
suming shares  and  bonds,  placing  the  new  industrials  on  the 
stock  market  and  selling  them  to  the  public.  There  is  no 
doubt  that  but  for  their  policy  of  furthering  the  industries, 
the  economic  development  of  Germany  would  have  taken  con- 
siderably longer  than  has  been  the  case. 

In  order  to  obtain  the  means  for  granting  industrial  credit 
and  to  dispose  of  the  enormous  amounts  of  newly  created 
industrial  securities,  it  was  and  is  necessary  to  attract  in  as 
large  a  measure  as  possible  the  surplus  funds  of  the  com- 
munity available  for  capital  investments.  For  this  purpose  the 
joint-stock  banks  spread  a  network  of  deposit  branches,  de- 
stined to  serve  as  reservoirs  for  the  inflow  of  available  funds, 
and  at  the  same  time  as  distributors  for  the  industrial  securi- 
ties created.  With  the  same  end  in  view  the  large  Berlin  banks, 
either  through  the  acquisition  or  exchange  of  stock  (for  per- 
manent investment),  entered  into  friendly  alliances  with  the 
provincial  banks. 

It  cannot  be  said  that  the  banks  created  our  industries,  since 
the  funds  which  are  gathered  by  the  banks  in  increasing  vol- 
ume are  mainly  the  result  of  the  increasing  productivity  of 
capital  invested  in  industrial  undertakings.  It  is  true,  how- 
ever, that  the  creative  power  which  in  a  comparatively  short 
time  placed  German  industry  in  its  present  commanding  posi- 
tion took  its  origin  with  the  men  who  put  to  practical  use  and 
in  the  interest  of  economic  progress  of  the  nation  the  achieve- 
ments and  inventions  in  the  domain  of  science  and  technique. 
It  is  the  undisputed  merit  of  the  persons  at  the  head  of  the 
banks  that  they  appreciated  those  endeavours  and  supported 
them  by  advancing  the  requisite  capital,  oftentimes  incurring 
great  risks  for  the  banks.  It  is  almost  self-evident  that  the 
banks,  which  in  carrying  out  their  policy  of  furthering  indus- 
try had  often  to  assume  considerable  risks,  have  tried  to  secure, 
and  in  a  large  measure  have  succeeded  in  securing,  a  lasting 
and  decisive  control  over  industrial  corporations. 

Until  the  seventies  of  the  last  century  the  financial  regula- 
tion of  German  foreign  oversea  trade  had  been  almost  exclu- 
sively in  the  hands  of  London  banks.  The  establishment  in 
1870  of  the  Deutsche  Bank  at  Berlin  meant  a  turning  point  in 


LAND  CREDIT  INSTITUTIONS  535 

this  regard.  The  founders  of  the  Deutsche  Bank  had  recog- 
nised that  there  existed  in  the  organisation  of  the  German 
banking  and  credit  system  a  gap  which  had  to  be  filled  in  order 
to  render  German  foreign  trade  independent  of  the  English 
intermediary,  and  to  secure  for  German  commerce  a  firm  posi- 
tion in  the  international  market.  It  was  rather  difficult  to 
carry  out  this  programme  during  the  early  years,  the  more  so, 
because  Germany  at  that  time  had  no  gold  standard  and  bills 
of  exchange  made  out  in  various  kinds  of  currency  were  neither 
known  nor  liked  in  the  international  market.  The  introduc- 
tion of  the  gold  standard  in  Germany  in  1873  did  away  with 
these  difficulties,  and  by  establishing  branches  at  the  central 
points  of  German  oversea  trade  (Bremen  and  Hamburg)  and 
by  opening  an  agency  in  London  the  Deutsche  Bank  succeeded 
in  vigorously  furthering  its  programme.  Very  much  later  the 
other  Berlin  joint-stock  banks,  especially  the  Disconto  Gesell- 
schaft  and  the  Dresdner  Bank,  followed  the  example  of  the 
Deutsche  Bank,  and  during  the  last  years  particularly  the  Ber- 
lin joint-stock  banks  have  shown  great  energy  in  extending 
the  sphere  of  their  interests  abroad. 

Among  the  customers  of  the  joint-stock  credit  banks  figure 
chiefly  members  of  the  commercial  and  industrial  classes,  who 
obtain  from  these  banks  both  their  long-  and  short-term  credit, 
and  in  the  second  place  holders  of  medium-sized  and  large 
agricultural  property,  who  apply  to  them  for  short-term  "  oper- 
ation "  credit.  The  credit  demands  of  the  members  of  the 
small-farm  class  and  of  the  small  independent  producers  are 
generally  met  by  the  co-operative  credit  societies. 

LAND    CREDIT    INSTITUTIONS 

As  regards  the  credit  on  landed  property  there  is  hardly  a 
country  with  an  organisation  as  perfect  as  Germany.  The  be- 
ginning of  this  organisation  dates  back  about  one  hundred 
and  thirty  years.  The  Prussian  State  had  emerged  from  the 
storms  of  the  Seven  Years'  War  (1756-1763)  as  a  recognised 
European  power,  but  the  sacrifices  of  the  years  of  war  had 
completely  exhausted  the  country. 

As  the  landed  nobility  was  then  the  principal  support  of  the 
State  and  was  so  regarded  by  the  Government,  it  became  a 


536  THE  GERMAN  BANKING  SYSTEM 

matter  of  public  interest  to  relieve  the  financial  distress  of  the 
landed  proprietors  by  enabling  them  to  pay  off  systematically 
their  mortgage  debts. 

The  efforts  in  this  direction,  in  which  the  Prussian  King, 
Frederick  the  Great,  personally  took  an  active  part,  led  to  the 
creation  of  the  land-mortgage  associations  (Landschaften}, 
which  must  be  considered  the  first  important  step  toward  the 
organisation  of  land  credit. 

"  Landschaften  "  are  associations  endowed  with  the  rights 
of  a  corporation  and  operating  under  state  control.  Their 
boards  of  directors  have  the  attributes  of  official  authority. 
They  are  autonomous  institutions  within  the  limits  set  by  the 
state  supervision. 

The  Landschaften  obtain  the  funds  for  the  granting  of 
credit  through  the  issues  of  letters  of  mortgage  or  mortgage 
bonds  —  i.  e.,  as  a  rule,  the  borrowers  receive  the  loan  in  the 
shape  of  mortgage  bonds  of  the  association,  and  it  is  left  to 
them  to  negotiate  these  bonds  on  the  stock  exchange.  At  first 
the  letters  of  mortgage  were  made  out  on  a  certain  estate  (es- 
tate debentures).  But  as  the  purchaser  of  such  letters  of 
mortgage  was  forced  to  keep  watch  over  the  condition  and 
management  of  the  mortgaged  estate  —  even  though  the  asso- 
ciation itself  maintained  permanent  control  of  the  debtor  — 
the  sphere  of  circulation  and  the  ease  with  which  these  bonds 
could  be  sold  were  naturally  limited. 

It  was  only  when  the  issue  of  corporate  mortgage  bonds  was 
started,  the  security  of  which  was  guaranteed  either  by  the 
entire  mortgage  claims  of  the  association  or  the  collec- 
tive responsibility  of  their  members,  and  when  these  bonds 
were  given  a  large  market  through  their  admission  to  ex- 
change transactions,  that  the  highest  degree  of  mobility  was 
reached. 

It  was  mainly  to  meet  the  needs  of  credit  on  urban  real 
estate  that  mortgage  banks  (Hypothekenbanken)  were  created, 
and  thus  a  special  organisation  of  city  real  estate  credit  was 
formed.  The  greater  number  of  the  mortgage  banks  now  in 
existence  was  founded  during  the  decade  1862  to  1872;  prac- 
tically all  the  others  were  founded  during  the  building  boom 
of  1894-1896.  Most  of  the  mortgage  banks  cater  exclusively 


LAND  CREDIT  INSTITUTIONS  537 

to  the  demand  for  real  estate  credit ;  some  others  combine  this 
specialty  with  other  lines  of  banking. 

While  the  land-mortgage  associations  are  based  on  the  prin- 
ciple of  co-operation  and  do  not  pursue  a  profit-making  policy, 
the  mortgage  banks  have  been  founded  as  joint-stock  com- 
panies. The  capital  stock  serves  as  working  capital  as  well  as 
guaranty  fund. 

Bonds  are  issued  against  acquired  mortgages  and  secured 
by  the  latter.  Almost  all  these  banks  issue  their  bonds  to 
bearer,  a  privilege  granted  them  by  the  State.  Inasmuch  as 
the  bonds  are  held  in  many  cases  by  small  investors,  the  State, 
in  order  to  protect  the  interests  of  these  bondholders,  from 
the  very  beginning  secured  to  itself  the  right  of  control,  Sm- 
iting at  the  same  time  the  field  of  operation  of  these  banks  by 
certain  legal  enactments  and  regulations. 

On  the  whole,  interest  rates  on  mortgage  loans  are  subject 
to  but  slight  variations.  It  should  be  remarked,  however,  that 
the  borrower  when  obtaining  a  mortgage  loan  has  to  pay  a 
bonus  the  rate  of  which  will  be  considerably  higher  in  times 
when  money  is  scarce  than  in  times  when  its  supply  is  re- 
dundant. 

In  times  of  a  large  increase  in  the  supply  of  bonds  the  mort- 
gage banks  may  go  into  the  market  to  buy  their  own  bonds. 
Such  action  prevents  serious  fluctuations  in  the  quotations  of 
these  securities  and  fits  them  to  be  objects  of  permanent  as 
well  as  temporary  investments,  including  the  investment  of 
funds  which  must  be  kept  in  liquid  shape. 

In  the  present  day  when  complaints  are  urged  against  the 
great  indebtedness  of  country  landowners,  the  fact  must  not 
be  lost  sight  of  that  the  transition  from  extensive  to  intensive 
operations  in  agriculture  could  not  have  been  accomplished 
without  a  wide  use  of  mortgage  credit,  and  that  such  develop- 
ment was  necessary  to  feed  the  rapidly  increasing  population 
of  the  country.  Moreover,  through  this  great  growth  in  the 
popu  V.ion  a  basis  was  created  for  industrial  activity  on  a  large 
scale. 


'538  THE  GERMAN  BANKING  SYSTEM 

RAIFFEISEN    AND    SCHULZE-DELITZSCH    BANKS 

1  The  Raiffeisen  bank  is  the  Schulze-Delitzsch  bank  applied 
to  the  country,  with  the  variations  required  and  justified  by 
the  difference  of  environment. 

The  model  rules  of  the  Raiffeisen  societies  state  that :  "  the 
object  of  the  society  is  to  improve  the  situation  of  its  mem- 
bers both  materially  and  morally,  to  take  the  necessary  steps 
for  the  same,  to  obtain  through  the  common  guarantee  the 
necessary  capital  for  granting  loans  to  members  for  the  de- 
velopment of  their  business  and  their  household,  and  to  bring 
idle  capital  into  productive  use,  for  which  purpose  a  savings 
bank  will  be  attached  to  the  society."  One  word  in  the  above, 
viz.,  "  morally,"  intimates  at  the  outset  a  distinctive  trait. 
Raiffeisen  ahvays  kept  the  moral  aspect  very  prominently  be- 
fore him.  He  insisted  that  all  the  members  of  his  institutions 
should  profess  the  Christian  virtues.  In  his  propaganda  he 
used  to  the  full  the  one  intelligent  power  in  rural  districts,  the 
parish  priest  or  pastor.  With. their  help  he  developed  a  new 
parochial  life  around  the  village  bank.  With  their  help  he 
touched  in  the  peasant  the  chord  of  neighbourly  affection  and 
stirred  him  to  give  it  practical  effect. 

What  is  the  structure  of  a  Raiffeisen  bank?  and,  first  of  all, 
whence  comes  the  working  capital? 

The  subscribed  capital  of  the  bank  is  practically  nil;  there 
is  nothing  but  the  universal  unlimited  liability  of  the  asso- 
ciating members.  Schulze-Delitzsch,  dealing  with  industrial- 
ists subject  to  unseen  risks,  who  operated  in  trade  matters  out 
of  sight  and  control  of  the  society,  obliged  his  associates  to 
subscribe  a  considerable  share  capital,  not  only  as  a  proof  of 
thrift,  but  as  a  material  guarantee  for  their  individual  and 
corporate  debts.  Raiffeisen,  dealing  with  agriculturists  and 
villagers,  demanded  no  such  security,  since  each  member  pos- 
sessed in  his  little  farm,  his  cattle  or  implements,  material 
guarantee  far  beyond  those  of  any  subscribed  share.  In  addi- 
tion he  avoided  the  danger  to  which  a  share  bank  is  always 
exposed,  namely,  that  the  concern  may  be  run  for  the  benefit 

1  Adapted  from  C.  R.  Fay,  Co-operation  at  Home  and  Abroad,  pp.  42-51, 
56.  P.  S.  King  and  Son,  London.  1908. 


CO-OPERATIVE  BANKS  539 

of  a  few  non-borrowing  shareholders,  rather  than  for  that  of 
the  general  credit-seeking  members. 

Unfortunately  this  natural  difference  was  elevated,  or  rather 
dragged  down,  into  an  issue  of  principle;  and  the  law  of  1889, 
drawn  up  under  the  guidance  of  the  Schulze-Delitzsch  party, 
insisted  that  every  co-operative  society  should  have  shares. 
The  Raiffeisen  societies  comply  with  this  by  nominal  shares  of 
(say)  10  marks1  on  which  no  dividend  is  declared;  though, 
occasionally,  some  of  the  annual  profit  is  indirectly  returned  to 
individuals  in  the  shape  of  a  slight  addition  to  deposit  rates 
and  a  slight  deduction  from  loan  charges,  calculated  at  the 
end  of  the  year. 

Because  Raiffeisen  wished  to  create  credit  among  small 
agriculturists  out  of  the  immaterial  asset  of  mutual  knowledge, 
he  limited  the  size  of  each  society  to  a  single  village.  For  his 
purpose  he  was  right,  but  his  partisans  are  not  right  when  they 
look  askance  at  the  larger  areas  of  the  town  bank,  where  the 
nature  of  the  members'  business  and  the  society's  control  is 
different. 

All  profits  remain  the  collective  property  of  the  society,  to 
be  used  for  the  society's  good.  They  are  divided  into  two 
classes  of  reserve  fund  — ( i )  reserve  fund  proper  5(2)  founda- 
tion fund.  The  former  is  regulated  in  the  same  way  as  in 
town  banks.  The  second  corresponds  to  the  shareholders'  divi- 
dend. It  is  undesirable  to  have  nothing  beyond  an  ordinary 
reserve  fund,  because  money  thus  placed  can  only  be  withdrawn 
to  cover  losses:  while  if  placed  in  the  foundation  fund  it  can 
be  used  for  positive  improvements,  such  as  the  extension  of 
premises  or  the  establishment  of  a  burial  fund.  In  actual  fig- 
ures, the  reserve  funds  are  not  so  strong  as  in  the  town  bank, 
owing  in  part  to  the  lower  loan  charges. 

The  loan  capital,  as  in  the  town  banks,  is  made  up  of  small 
savings  and  deposits.  It  is  drawn,  either  from  within  the  area 
covered  by  the  bank,  in  which  case  it  comes  both  from  mem- 
bers and  non-members,  the  former  being  where  possible  re- 
warded at  slightly  higher  rates  in  order  to  encourage  member- 
ship :  or  from  without  the  area,  in  which  case  it  of  necessity 
comes  from  non-members.  Savings  are  received  in  sums  from 

1  Occasionally  even  as  low  as  I d.  or  less. 


540  THE  GERMAN  BANKING  SYSTEM 

one  mark  upwards :  the  smaller  amounts  being  collected  by 
penny  stamp  books,  similar  to  those  used  in  the  Post  Office 
Savings  banks  of  England.  The  willingness  with  which  the 
peasants  bring  their  savings  to  the  bank  is  a  triumphant  proof 
of  Raiffeisen's  contention  that  the  small  agriculturists  by  a 
combination  of  unlimited  liability  and  close  supervision  can 
become  absolutely  credit-worthy.  No  savings  since  the  foun- 
dation of  the  first  village  bank  have  ever  been  lost  through 
bankruptcy. 

In  addition  the  bank  obtains  credit  from  a  central  bank  with 
which  it  has  a  current  account. 

The  funds  thus  raised  are  utilised  for  three  kinds  of  credit  — • 
(i)  Simple  loans;  (2)  current  accounts;  (3)  property  trans- 
fers. 

Current  accounts  are  rare  except  in  villages  where  there  is 
a  little  industry.  With  regard  to  the  simple  loan,  the  security, 
as  in  town  banks,  is  personal  pledge,  land  mortgage,  or  (very 
rarely)  deposit  of  collateral.  The  personal  pledge,  as  with 
Schulze-Delitzsch,  is  the  most  frequent.  But  Raiffeisen  inter- 
preted it  more  strictly  than  Schulze-Delitzsch.  Not  only  must 
the  credit-seeker  produce  an  outside  testimony  to  his  character : 
he  must  also  convince  his  society  that  he  really  merits  this  tes- 
timony. The  member  of  the  Schulze-Delitzsch  bank  is  ac- 
cepted on  the  strength  of  his  general  business  reputation,  added 
to  his  security,  personal  or  material.  The  member  of  the 
Raiffeisen  bank,  though  he  have  the  best  of  pledges,  is  rejected 
unless  he  is  known  in  his  private  life  to  be  virtuous  and  indus- 
trious. The  man  of  doubtful  sobriety  has  no  chance  of  ob- 
taining anything  from  a  country  bank. 

If  it  happen  that  an  applicant  is  little  known  or  new  in  the 
district,  so  that  no  one  will  go  pledge  for  him,  then  the  society, 
provided  it  is  convinced  of  his  good  character,  will  grant  a 
loan  against  land  mortgage.  This  is  not  to  be  confused  with 
the  real  credit  granted  by  a  land  bank,  where  the  value  of  the 
estate  alone  is  considered.  It  is  personal  credit  with  a  mate- 
rial caution,  and  it  is  not  a  long-term  loan. 

Furthermore,  the  society  requires  to  know  not  only  the 
character  of  the  borrower,  but  also  the  specific  object  for  which 
his  loan  is  destined.  It  must  be  satisfied  not  only  that  the 


CO-OPERATIVE  BANKS  '541 

borrower  wishes  to  employ  the  loan  in  his  business,  but  also 
that  the  operation  proposed  is  likely  to  turn  out  successful. 

Property  transfers  are  not  strictly  credit  business.  They 
are  in  the  nature  of  investments  for  superfluous  money,  just 
as  a  town  bank  might  invest  in  railway  shares,  with  the  differ- 
ence that  the  investment  is  local  and  designed  to  meet  indi- 
rectly the  credit  wants  of  members.  The  nature  of  the  opera- 
tion is  as  follows :  A  dies,  leaving  his  estate  to  his  heirs ;  and 
these,  perhaps  because  they  wish  to  leave  the  neighbourhood 
or  because  they  want  ready  money  for  other  reasons,  put  up 
the  estate  for  sale  in  allotments.  Or  perhaps  A  during  his  life- 
time wishes  to  get  rid  of  a  part  of  his  estate.  X,  Y,  Z,  neigh- 
bouring peasants,  are  buyers,  but  they  can  pay  only  gradually 
—  which  they  are  allowed  to  do  by  law.  The  credit  bank 
steps  in  as  intermediary.  It  pays  to  the  heirs  of  A  or  to  A 
himself,  as  the  case  may  be,  the  price  of  the  estate  minus  a 
small  commission.  X,  Y,  Z  become  the  debtors  of  the  credit 
society,  paying  off  their  debt  by  regular  instalments,  which 
include  principal  and  interest.  The  bank  cuts  out  small  traf- 
fickers in  land,  usually  Jews,  to  the  benefit  of  sellers  and  buy- 
ers. It  benefits  the  sellers  by  charging  them  a  moderate  in- 
stead of  an  extravagant  commission :  the  buyers  by  saving 
them  from  permanent  relationship  with  land  dealers  who  seek 
their  ruin.  The  bank  insists  on  regular  payment  of  the  in- 
stalments, because  it  wants  its  money  back,  while  the  dealer  is 
constantly  tempting  the  buyers  to  fall  into  arrears  in  order 
that  he  may  eventually  acquire  the  land  himself. 

There  is  a  second  form  of  property  transfer,  where  the  bank 
not  only  acts  as  intermediary  but  itself  holds  the  estate  for  a 
time.  Some  land  dealer,  having  obtained  a  mortgage  on  the 
estate  of  A,  demands  payment.  A  cannot  pay  and  is  forced 
to  sell  his  estate  by  public  auction.  The  dealer  forces  the  sale, 
just  when  the  estate  market  is  likely  to  be  most  unfavourable, 
hoping  to  buy  the  estate  for  himself  at  an  absurdly  low  rate. 
Thereupon  the  bank  steps  in;  it  bids  against  the  dealer,  and  if 
he  does  not  offer  a  good  price,  buys  the  estate  itself  and  re- 
sells it  later  in  the  year,  when  the  market  is  more  favourable. 
In  this  way  A  can  pay  off  fris  debts  at  once.  Moreover,  the 
bank  does  not  keep  the  difference  between  the  price  of  pur- 


'542  THE  GERMAN  BANKING  SYSTEM 

chase  and  final  re-sale.  After  the  deduction  of  a  moderate 
commission,  it  is  handed  over  to  A,  who  thus  obtains  a  further 
sum  with  which  he  can  make  a  fresh  start. 

These  dealings  in  property  transfers  are  confined  to  South- 
west Germany,  where  estates  are  sold  to  be  split  up  into  little 
lots.  The  banks  only  enter  on  these  transactions  where  the 
following  conditions  are  satisfied  —  (a)  where  they  have  a 
superfluity  of  money  over  and  above  that  needed  in  their  ordi- 
nary loan  business;  (b)  where  some  party  to  the  transaction  is 
a  member  of  the  society :  either  the  seller  or  the  buyer  or  the 
creditors  of  the  seller  holding  second  and  third  mortgages, 
who  would  obtain  nothing  were  the  estate  sold  below  its  real 
value. 

What  is  the  nature  of  the  machinery  by  which  this  wrork  is 
conducted?  A  Raiffeisen  bank  is  never  what  a  Schulze- 
Delitzsch  bank  sometimes  is ;  a  handsome  building  with  barred 
windows,  within  which  are  a  number  of  clerks  discharging 
a  constant  round  of  business,  wrhile  the  directors  interview 
special  clients  in  a  room  apart.  It  is  a  small  single  room, 
probably  at  the  back  of  a  farm  building,  opened  twice  a  week 
and  presided  over  by  a  single  occupant  —  the  accountant. 
Business  is  apt  to  proceed  desultorily ;  a  small  child  brings  in  a 
few  savings;  an  hour  afterwards  a  palsied  old  man,  signing 
by  a  cross,  draws  out  a  couple  of  pounds,  and  so  on  to  the  end 
of  the  day.  But  this  is  the  unimportant  part  of  the  business. 
The  really  important  part  is  the  weekly  meeting  of  the  di- 
rectors, half  a  dozen  in  number,  who  meet  to  discuss  the  va- 
rious credit  claims  which  have  arisen.  They  are  unpaid,  as 
by  the  nature  of  their  work  they  can  afford  to  be.  The  ac- 
countant, their  executive  clerk  who  keeps  the  books,  "  the  soul 
of  the  society,"  as  Raiffeisen  called  him,  is  the  only  salaried 
official.  The  committee  of  supervision  and  the  general  assem- 
bly function  as  in  the  town  banks;  except  that  their  control 
is  more  decided,  probably  because  their  knowledge  is  more 
on  a  level  with  that  of  the  directorate,  which  is  itself  unspecial- 
ised. 

What  are  the  results  achieved  by  the  rural  bank,  thus  oper- 
ating and  thus  controlled  ? 

More  than  ten  times  the  number  of  country  banks  grant 


CO-OPERATIVE  BANKS  543 

only  one-sixth  of  the  credit  afforded  by  the  town  banks.  The 
total  membership  of  the  country  banks  is  nearly  twice  as  large, 
but  the  average  membership  per  bank  is  nearly  seven  times  as 
small. 

The  average  credit  advanced  per  member  is  500  marks. 
The  average  rate  of  interest  is  not  exactly  known;  it  appears 
to  be  between  4  and  5  per  cent.,  i.  c.,  nearly  i  per  cent,  cheaper 
than  in  the  town  bank.  The  duration  of  loans  varies  between 
one  and  ten  years  in  accordance  with  the  requirements  of  agri- 
culture. They  are  repayable  in  small  instalments,  covering 
principal  and  interest,  although  the  member  may  repay  in  lump 
if  he  wishes.  The  loan  can  always  be  called  on  four  weeks' 
notice,  but  the  right  is  never  exercised,  unless  the  borrower 
is  allowing  his  property  to  deteriorate  or  is  becoming  insolvent 
through  extravagance  or  has  misapplied  money  lent  for  a 
particular  purpose.  The  inculcation  of  punctuality  in  pay- 
ment, as  a  moral  duty,  was  the  hardest  of  Raiffeisen's  tasks, 
as  it  was  his  greatest  triumph. 

If  it  be  asked  finally  what  Raiffeisen  banks  have  done,  which 
other  banks  have  not,  it  may  be  replied  that  Raiffeisen  created 
out  of  hopeless  chaos  the  only  kind  of  credit  organisation  pos- 
sible for  the  small  argiculturist.  Industry  necessarily  brings 
business  men  together  to  some  extent.  Agriculture  in  itself 
holds  the  farmer  apart,  and  preserves  him  in  lonely  ignorance 
to  be  the  victim  of  the  perambulating  money-lender.  To-day 
more  than  50  per  cent,  of  the  independent  agriculturists  of 
Germany  are  members  of  rural  banks;  and  another  10  per 
cent.,  chiefly  the  larger  farmers,  are  members  of  town  banks. 
The  non-co-operative  agriculturist  is  becoming  the  exception. 
The  Raiffeisen  banks  are  thickest  in  the  southwest  of  Ger- 
many, the  home  of  the  small  peasant  proprietors.  Indeed  the 
change  wrought  in  many  of  these  villages  is  nothing  short  of 
a  revolution.  The  experience  of  the  parent  village  bank  may 
serve  in  illustration : 

"  About  an  hour's  walk  from  Neuwied  on  the  Rhine  is  sit- 
uated on  a  plateau  bordering  the  Westerwald  the  little  vil- 
lage of  Anhausen.  The  district  is  not  very  fertile  and  the 
inhabitants  are  mostly  small  peasant  proprietors,  some  with 
only  sufficient  land  to  graze  a  single  ox  or  cow.  An  owner  of 


544  THE  GERMAN  BANKING  SYSTEM 

ten  acres  is  a  rich  man.  Before  the  year  1862  the  village  pre- 
sented a  sorry  aspect ;  rickety  buildings,  untidy  yards,  in  rainy 
weather  running  with  filth;  the  inhabitants  themselves  ragged 
and  immoral ;  drunkenness  and  quarrelling  universal.  Houses 
and  oxen  belonged  with  few  exceptions  to  Jewish  dealers. 
Agricultural  implements  were  scanty  and  dilapidated ;  and 
badly-worked  fields  brought  in  poor  returns.  The  villagers 
had  lost  confidence  and  hcpe,  they  were  the  serfs  of  dealers 
and  usurers.  To-day  Anhausen  is  a  clean  and  friendly-looking 
village,  the  buildings  well  kept,  the  farmyards  clean  even  on 
work  days.  The  inhabitants  are  well  if  simply  clothed,  and 
their  manners  are  reputable.  They  own  the  cattle  in  their 
stalls.  They  are  out  of  debt  to  dealers  and  usurers.  Modern 
implements  are  used  by  nearly  every  farmer,  the  value  of  the 
farms  has  risen  and  the  fields,  carefully  and  thoroughly  culti- 
vated, yield  large  crops."  And  this  change,  which  is  some- 
thing more  than  statistics  can  express,  is  the  work  of  a  simple 
Raiffeisen  bank. 

Both  town  and  country  banks  are  formed  into  higher  unions 
for  general  organisation  and  educational  propaganda;  the 
country  banks  also  unite  for  credit  business. 

The  partisans  of  the  town  banks  are  apt  to  pride  themselves 
on  their  complete  self-sufficiency.  They  forget  that  this  is 
possible  for  them,  not  because  they  have  sufficient  funds  in 
their  own  coffers  to  supply  every  credit  need,  but  because  an 
increasing  part  of  their  business  is  conducted  through  the  trade 
bill  of  exchange,  which  is  a  marketable  commodity  that  can  be 
re-discounted  by  any  outside  bank,  the  Imperial  Bank,  the 
Dresdner  Bank  or  any  other.  But  agricultural  societies,  inas- 
much as  their  loan  papers  cannot  readily  be  bought  and  sold 
on  the  open  market,  require  a  special  organisation.  Hence 
central  organisations  act  as  money  equalisers  between  the  dif- 
ferent societies.  In  some  districts  money  is  superabundant, 
in  others  it  is  deficient.  The  central  bank  acts  as  a  channel 
through  which  the  abundance  of  one  district  can  be  drawn 
to  supply  the  scarcity  of  another,  the  operations  being  con- 
ducted by  means  of  current  accounts  with  both  parties.  In 
Germany  as  a  whole  the  societies  of  small  agriculturists  of  the 
Southwest  have  always  an  abundance  of  money,  which  is  one 


CO-OPERATIVE  BANKS  545 

reason  why  they  dispense  so  much  of  their  funds  in  the  pur- 
chase of  property  transfers.  The  societies  of  large  agricul- 
turists in  the  Northeast  (the  Ost-Elbien  Provinces),  where  the 
capital  employed  on  each  farm  is  large  and  the  population 
thin,  are  as  a  whole  in  continual  want  of  it. 

INTERVIEW  WITH  HERR  KLEEMANN,  DIRECTOR  OF  THE 
DRESDNER  BANK 

1  Q.  When  were  the  first  of  your  co-operative  societies  or- 
ganised ? 

A.  In  1848.  They  were  organised  on  a  voluntary  basis 
and  for  philanthropic  purposes.  They  developed  very  rapidly. 
The  first  form  which  developed  was  for  the  purchase  of  means 
of  subsistence,  such  as  sugar,  coffee,  grain,  wine,  cigars,  etc. 
Then  they  bought  agricultural  machinery,  threshing  machines, 
etc.,  which  they  would  rent  to  small  farmers  in  the  country 
who  could  not  purchase  such  machinery.  They  also  formed 
societies  to  build  houses  for  peasants  and  working  people. 
There  might  be  six  or  seven  with  different  purposes.  Later 
on  Schulze-Delitzsch  came  to  the  conclusion  that  it  would 
serve  working  people  and  small  tradesmen  to  have  co-opera- 
tive societies  founded  simply  for  the  purpose  of  extending 
credit  to  them.  That  was  the  last  development  in  the 
system. 

Q.  How  many  kinds  of  co-operative  societies  are  there  in 
Germany  ? 

A.  It  is  very  difficult  to  classify  them.  The  Raiffeisen  so- 
cieties are  confined  to  Prussia.  There  are  other  organisations 
in  Saxony,  Bavaria,  and  different  States  in  Germany. 

Q.  The  attitude  of  the  Reichsbank  is  the  same  toward  them 
as  toward  any  other  bank  ? 

A.  Yes;  and  their  bills  are  frequently  offered  and  taken  by 
the  Reichsbank  as  from  other  institutions. 

Q.  Do  they  carry  their  reserve  with  the  Reichsbank  or  with 
the  Dresdner  Bank? 

1Adapted  from  Interviews  on  the  Banking  and  Currency  Systems  of 
England,  Scotland,  France,  Germany,  Switzerland,  and  Italy,  Publications 
of  the  National  Monetary  Commission,  Senate  Document  No.  405,  6ist 
Congress,  2cl.  Session,  pp.  452-468. 


•546  THE  GERMAN  BANKING  SYSTEM 

A.  Principally  with  the  Dresdner  Bank,  because  they  get 
interest  upon  it. 

O.  Do  they  pay  interest  on  deposits? 

A.  They  pay  an  average  of  4  per  cent,  which  may  be  con- 
sidered as  an  almost  permanent  rate.  The  money  they  get  is 
in  most  cases  money  for  a  long  period.  They  have  to  com- 
pete with  the  savings  banks. 

Q.  Are  the  small  societies  at  all  in  competition  with  the 
Reichsbank,  where  they  have  a  branch? 

A.  No.  There  is  no  competition.  They  do  a  business 
which  the  Reichsbank  would  not  do.  They  give  credit  to  peo- 
ple who  would  not  suit  the  Reichsbank,  because  they  could  not 
give  the  guarantee. 


INTERVIEWS  WITH  HERR  DR.  VON  GLASENAPP,  VICE-PRESIDENT, 

AND  HERR  DR.   VON   LUMM,   DIRECTOR,  OF  THE 

REICHSBANK  1 

Q.  By  whom  are  the  shares  of  the  Reichsbank  owned? 

A.  It  is  all  private  ownership.  The  shares  are  held  mostly 
in  Germany  and  Holland,  and  distributed  in  small  lots. 

Q.  Would  the  bank  discount  a  bill  drawn  by  one  merchant 
and  accepted  by  another? 

A.  Yes.  The  Reichsbank  is  not  only  a  bank  for  banks, 
but  for  the  commercial  and  industrial  enterprises  of  the  Em- 
pire. 

Q.  If  a  railroad  finds  it  necessary  to,  make  improvements 
and  wants  to  borrow  money  could  they  get  money  at  the 
Reichsbank  ? 

A.  Only  on  collateral  acceptable  by  the  Reichsbank.  The 
railroad  would  probably  in  such  a  case  go  to  private  banks 
to  be  financed. 

Q.  Assume  that  there  is  a  manufacturer  in  Bremen,  making 
well-known  articles,  which  he  ships  to  a  merchant  in  Berlin 
and  draws  a  bill  against  that  merchant,  would  it  be  a  satis- 
factory bill  to  the  Reichsbank? 

A.  Yes ;  but  in  that  instance  also  the  merchant  would  prob- 

iU,  pp.  335-358. 


THE  REICHSBANK  547 

ably  go  to  the  private  bank,  where  he  would  get  a  better  rate 
of  discount. 

O.  If  there  were  a  severe  money  stringency,  would  he  still 
go  to  his  bank  ? 

A.  Yes ;  that  would  probably  be  the  case,  and  his  bank  might 
afterwards  take  his  bills  to  the  Reichsbank. 

Q.  What  is  the  smallest  bill  the  bank  will  discount? 

A.  We  have  no  minimum.  We  discount  bills  as  low  as 
10  marks. 

Q.  Upon  what  kind  of  a  bill  does  the  farmer  secure  an 
advance  from  the  bank  ? 

A.  He  sells  his  produce,  draws  a  bill  upon  the  purchaser, 
and  takes  the  bill  to  the  bank  as  any  other  man  would  do, 
or  a  bill  might  be  drawn  upon  a  farmer  and  accepted  by  him. 

Q.  When  he  borrows  money  in  the  spring  with  which  to 
buy  seeds,  how  does  he  secure  the  cash? 

A.  He  goes  to  his  own  bank  for  that.  There  are  co-opera- 
tive societies  for  this  purpose,  which  are  a  great  factor  in 
Germany. 

Q.  Will  the  manager  of  a  branch  of  the  Reichsbank  renew 
a  farmer's  three  months'  bill  if  desired? 

A.  Yes;  an  exception  is  made  for  the  farmer.  Other  bills 
are  not  renewed. 

Q.  The  bank  rate  is  4  per  cent.  Does  that  mean  4  per  cent, 
is  charged  on  three  months'  bills  ? 

A.  The  Reichsbank  has  only  one  rate  of  discount.  There 
was  a  time  when  the  Reichsbank  did  a  similar  business  to  that 
which  the  Bank  of  England  does  now,  i.  e.,  tha*t  they  would 
purchase  in  the  market  prime  bills  at  a  more  favourable  rate, 
but  in  1896  it  was  decided  to  have  but  one  rate  for  everybody. 

Q.  Please  state  the  reason  for  the  change  of  policy. 

A.  The  most  important  reason  was  that  it  was  thought  that 
a  great  central  institution  like  the  Reichsbank,  with  its  tasks 
and  duties  to  the  whole  of  the  community,  ought  not  to  make 
a  distinction  of  any  class,  or  make  an  exception  in  favour  of 
any  one.  It  is  the  policy  of  the  bank  to  serve  all  alike. 

Q.  Is  the  Reichsbank  disposed  to  favour  every  application 
for  discount  or  loans  if  the  character  of  the  offering  be  satis- 
factory ? 


548  THE  GERMAN  BANKING  SYSTEM 

A.  It  is  their  duty  to  listen  to  every  one  who  comes  for 
accommodation,  whether  he  has  an  account  or  not.  The  prin- 
ciple of  the  Reichsbank  is  not  to  serve  a  part  of  the  com- 
munity, but  the  whole.  The  Reichsbank  is  for  everybody. 

Q.  Are  your  deposits  subject  to  check? 

A.  The  money  is  drawn  against  check.  There  are  two 
kinds  of  check  —  white  and  pink.  The  white  is  for  with- 
drawing cash  over  the  counter,  the  pink  for  making  transfers. 

Q.  Have  you  different  classes  of  deposits  ? 

A.  No. 

Q.  Do  you  pay  interest  on  your  deposits  ? 

A.  The  Reichsbank  does  not  pay  interest  on  money  de- 
posited with  it.  It  receives  money  on  deposit  and  for  transfer. 
Most  large  houses  keep  an  account  with  the  Reichsbank.  The 
Reichsbank  does  a  large  transfer  business  for  them. 

Q.  Is  it  the  custom  for  banks  in  Berlin  and  other  important 
centres  to  carry  balances  in  the  Reichsbank  as  a  part  of  their 
reserve  ? 

A.  It  is  the  custom  for  the  banks  to  keep  a  large  part  of 
their  cash  with  the  Reichsbank.  They  keep  only  a  small 
amount  of  cash  in  their  tills. 

Q.  Is  that  true  of  banks  in  other  cities  than  Berlin? 

A.  Yes. 

Q.  Does  the  Reichsbank  pay  the  same  taxes  that  the  other 
banks  do  ?  For  instance,  income  tax  and  other  taxes  ? 

A.  No ;  we  are  free  from  the  government  income  tax,  and 
the  license  fees,  but  we  must  pay  the  real-estate  tax. 

Q.  What  is*  the  relation  between  this  bank  and  other  banks, 
such  as  the  Deutsche  and  the  Dresdner  —  that  is,  as  to  the 
character  of  business  transacted?  Are  you  not  competitors? 

A.  It  may  be  said  that  the  Reichsbank  is  more  restricted  by 
law.  At  a  private  bank  the  rate  of  discount  may  be  much 
cheaper  than  at  the  Reichsbank.  The  private  banker  knows 
his  clients,  and  he  may  be  willing  to  accept  from  them  a  bill 
that  the  Reichsbank  would  not  and  could  not  accept. 

Q.  Then  there  is  to  some  extent  competition? 

A.  Yes;  but  that  competition  is  not  large.  It  is  not  felt 
that  the  Reichsbank  is  a  competitor  of  other  banks,  but  it  is 
a  public  institution.  The  Reichsbank  has  its  official  rate, 


THE  REICHSBANK  549 

which  is  higher  than  the  private  rate.  A  bank  will  take  bills 
on  its  own  account  running  three  months  or  more  and  hold 
them,  and  in  case  of  need  will  take  bills  running  ten  days  or 
less  to  the  Reichsbank  for  discount.  The  Reichsbank  pays 
no  interest  and  acts  as  agent  for  transfer  of  currency  and 
credit  to  all  parts  of  the  Empire  without  charge. 

Q.  Has  there  been  any  feeling  that  your  branches  were 
supplanting  the  private  local  banks  in  small  towns? 

A.  There  may  have  been  some  instances  where  a  banker  may 
have  been  dissatisfied  at  the  Reichsbank  opening  a  branch  in 
his  locality,  but  as  a  rule  the  banks  at  such  a  place  are  quite 
pleased  to  have  the  Reichsbank  open  a  branch  in  order  that 
they  may  have  the  benefits  of  its  facilities. 

Q.  The  government  deposits  are  received  and  treated  ex- 
actly the  same  as  the  deposits  of  farmers? 

A.  Yes.  The  business  for  the  Government  and  its  depart- 
ments is  handled  the  same  as  for  others,  and  no  interest  is 
paid  on  deposits.  There  is,  however,  one  exception;  every 
private  institution  is  required  to  keep  a  minimum  balance  to 
its  credit,  but  not  so  with  the  departments  of  the  Govern- 
ment. The  Empire  keeps  in  the  aggregate  sufficient  to  com- 
pensate. 

Q.  Do  you  always  charge  a  higher  rate  of  discount  for  bills 
when  you  have  a  large  amount  of  taxed  notes  outstanding? 

A.  No.  On  occasions  the  Reichsbank  has  not  increased  its 
rate  of  discount  above  5  per  cent.  At  times  we  have  dis- 
counted even  at  3  per  cent.,  when  we  have  had  to  pay  a  tax 
of  5  per  cent. 

Q.  It  has  been  suggested  to  us  as  a  matter  of  policy  in  times 
of  stress  that  it  would  be  better  for  you  to  add  the  5  per  cent, 
tax  to  the  rate  of  discount. 

A.  The  Reichsbank  must  be  considered  in  the  first  place  as 
a  public  institution  which  has  to  take  care  of  the  public  inter- 
est, and  secondarily  as  a  money-making  institution. 

Q.  Is  there  any  restriction  as  to  the  percentage  of  silver  in 
your  reserve? 

A.  No ;  but  there  is  another  law,  the  coinage  act,  by  which 
the  amount  of  silver  coined  depends  upon  the  population. 
They  do  not  coin  more  than  20  marks  per  capita. 


'550  THE  GERMAN  BANKING  SYSTEM 

Q.  What  steps  do  you  take  to  increase  your  gold  reserve  or 
to  protect  it? 

A.  We  always  have  a  large  amount  of  bills  of  exchange 
payable  in  foreign  countries,  payable  in  gold.  We  also  in- 
crease the  rate  of  discount.  We  consider  that  the  latter  meas- 
ure is  the  only  effective  one.  We  also  make  advances  with- 
out interest  to  importers  for  the  time  the  gold  is  in  transit; 
we  do  that  even  in  times  when  the  ordinary  gold  import  point 
is  not  reached.  Then  we  may  raise  our  tariff  for  the  pur- 
chase of  foreign  gold  coins,  as  the  Bank  of  England  does. 

Q.  Do  you  take  any  steps  to  prevent  exports  of  gold?  We 
have  been  told  that  it  is  the  habit  of  the  Reichsbank,  in  case 
of  large  exports  of  gold  from  Germany,  to  suggest  to  the  other 
banks  that  it  is  not  agreeable  to  have  the  gold  exported. 

A.  It  has  never  been  the  case  and  never  will  be  the  case 
that  any  such  suggestion  has  been  made  by  the  Reichsbank 
to  anybody. 

KONIGLICHE  SEEHANDLUNG 
(ROYAL  SEA-TRADE  SOCIETY) 

INTERVIEW    WITH    HERR    GEH.    OBERFINANZRAT    LOTTNER,    DI- 
RECTOR OF  THE  ROYAL  SEEHANDLUNG,  PRUSSIAN  STATE 

BANK  1 

Q.  When  was  this  bank  organised? 

A.  In  1772. 

Q.  What  is  the  capital  of  the  bank? 

A.  One  hundred  million  marks. 

Q.  By  whom  are  the  shares  owned  ? 

A.  There  are  no  shares;  the  capital  is  owned  by  the  bank, 
which  may  be  regarded  as  a  juristic  person,  an  independent 
legal  subject. 

Q.  Who  invested  the  money  ? 

A.  The  money  was  originally  invested  by  stockholders  in 
the  time  of  Frederick  II,  but  afterwards  the  shareholders  gave 
up  their  stock,  for  which  they  were  paid.  The  shares  were 
mostly  owned  by  the  King  and  by  his  associates,  and  they 
handed  them  over  to  the  bank,  so  the  capital  is  really  owned 

.,  pp.  359-370. 


KONIGLICHE  SEEHANDLUNG  551 

by  the  bank  itself.  The  proceeds  in  excess  of  all  the  expenses 
are  paid  to  the  Prussian  State. 

Q.  Who  is  responsible  for  the  conduct  of  the  business? 

A.  The  president. 

Q.  Has  he  associated  \vith  him  directors? 

A.  No ;  he  is  personally  responsible. 

Q.  By  whom  is  the  president  appointed? 

A.  By  the  King  of  Prussia  for  life. 

Q.  What  are  the  particular  functions  of  the  bank? 

A.  In  the  first  place,  it  is  an  organisation  to  help  the  State 
of  Prussia.  The  principal  part  of  the  business  is  to  finance 
the  loans  of  the  State.  It  may  undertake  the  loans  alone,  but 
as  a  rule  it  heads  a  syndicate  of  the  large  banks. 

Q.  Do  you  compete  for  deposits  from  merchants,  manufac- 
turing concerns,  banks,  etc.,  with  the  Deutsche  Bank  or  the 
Dresdner  Bank? 

A.  Yes,  to  some  extent.  It  is  not  our  intention  to  do  so, 
but  of  course  we  practically  compete  in  some  ways.  Our  rates 
on  deposits  are  less  favorable  than  those  of  these  banks. 

Q.  Do  you  take  real  estate  mortgages? 

A.  No. 

Q.  You  are  known  as  the  sea-trade  (Seehandlung)  society. 
Why  is  that? 

A.  Frederick  the  Great  founded  the  Seehandlung  to  pro- 
mote Prussian  trade,  especially  the  over-sea  trade.  At  one 
time  this  company  had  a  salt  monopoly  and  a  wax  monopoly. 
The  salt  which  came  into  the  different  ports  of  Prussia  and 
the  wax  which  came  from  Poland  were  bought  up  by  the  See- 
handlung. At  one  time  the  Seehandlung  also  had  mills,  spin- 
ning and  weaving  plants,  iron  foundries,  and  river  steamers. 
We  still  own  two  industrial  establishments,  the  flour  mills  in 
Bromberg  and  a  linen  spinnery  in  Landeshut  in  Silesia. 

Q.  A  large  percentage  of  your  funds  is  loaned  on  the  stock 
exchange  ? 

A.  Yes. 

Q.  And  your  discount  business  is  comparatively  insignifi- 
cant? 

A.  Not  insignificant,  but  small  compared  with  our  loans  on 
the  stock  exchange. 


'552  THE  GERMAN  BANKING  SYSTEM 

Q.  Do  you  receive  promissory  notes  from  customers? 

A.  No. 

Q.  Do  you  transact  business  of  any  other  character  than 
that  heretofore  mentioned? 

A.  We  have  a  branch  known  as  the  Royal  Loan  Office,  \vhich 
lends  money  in  small  amounts  upon  the  pledge  of  different 
kinds  of  goods  as  security.  This  was  established  in  1834.  In 
1906  we  made  99,000  loans  upon  watches,  jewels,  clothing,  etc., 
at  an  average  of  31  marks  per  loan.  Two-thirds  of  the  bor- 
rowers are  labourers;  last  year  about  16  per  cent,  were  widows 
and  spinsters,  also  a  few  were  mechanics  —  occasionally  pro- 
fessional men  —  artists,  actors,  and  the  like.  Our  rate  is  very 
low,  12  per  cent,  for  the  year,  which  is  low  compared  with  the 
ordinary  pawnshops.  No  other  banks  conduct  a  business  of 
this  class. 

DEUTSCHE  BANK 

INTERVIEWS  WITH  HERR  PAUL  MANKIEWITZ,  DIRECTOR,  AND 

HERR  A.  BLINZIG,  ALTERNATE,  OF  THE 

DEUTSCHE  BANK  1 

Q.  When  was  your  bank  organised? 

A.  In  the  year  1870. 

Q.  How  is  your  stock  owned? 

A.  By  a  large  number  of  shareholders.  Our  shareholders 
are  principally  in  Germany,  but  also  in  England,  France,  Aus- 
tria, and  elsewhere. 

Q.  Wrhat  does  the  item  "  Shares  in  other  banks,"  $19,000,- 
ooo,  represent? 

A.  This  represents  the  purchase  by  us  of  practically  the  con- 
trolling interest  in  13  independent  banks  in  the  Empire.  We 
are  represented  upon  each  board  and  we  are  kept  closely  in- 
formed of  the  business.  Our  return  is  in  the  dividends. 

Q.  A  large  percentage  of  the  stock  exchange  business  is 
really  handled  through  the  incorporated  banks,  is  it  not? 

A.  Yes.  We  ourselves  have  fifty  members  on  the  stock  ex- 
change. 

Q.  You  mean  that  the  Deutsche  Bank  has  fifty  men,  mem- 

1  Ibid.,  pp.  371-391. 


THE  DEUTSCHE  BANK  553 

bers  of  the  stock  exchange,  who  trade  there  on  the  floor? 

A.  Yes.  There  is  quite  a  difference,  however,  in  our 
method  of  handling  the  business  from  that  followed  in  New 
York.  We  do  not  have  the  margin  system.  Most  of  our  cus- 
tomers who  do  not  pay  in  full  pay  at  least  for  half  the  amount 
involved  in  the  purchase. 

Q.  Are  the  clearing-house  associations  important  factors  in 
the  cities  in  Germany? 

A.  No.  They  are  not  associations  of  importance  or  power, 
but  merely  pieces  of  machinery  through  which  cheques  are 
cleared. 

Q.  You  all  go  to  the  Reichsbank  to  clear  ? 

A.  Yes;  once  a  day.  There  are  14  clearing  houses  and  160 
members  in  the  Empire. 

Q.  What  taxes  do  you  have  to  pay? 

A.  We  pay  to  the  State  4  per  cent,  on  our  income  remain- 
ing after  deduction  of  3^  per  cent,  of  our  share  capital,  which 
is  exempt,  and  to  the  city  of  Berlin  4  per  cent,  on  our  income. 
All  banks  pay  on  the  same  basis. 

Q.  Is  there  a  limit  to  the  amount  of  discretion  given  to  the 
branch  directors  on  first-class  bills? 

A.  Each  of  the  main  branches  has  a  fixed  capital  arbitrarily 
set  aside  by  the  Deutsche  Bank.  They  have  a  sum  according 
to  the  importance  of  the  branch,  and  they  must  do  business 
according  to  it. 

Q.  The  Reichsbank  has  branches  everywhere? 

A.  Yes ;  in  every  place  where  there  is  sufficient  business.  It 
has  about  500  branches.  We  transferred  through  the  Reichs- 
bank last  year  21,000,000,000  marks.  Our  strength  is  the 
Reichsbank.  Our  branch  in  Bremen,  for  instance,  wants 
money  when  cotton  shipments  start,  and  the  money  is  trans- 
ferred to  them.  The  importers  in  Bremen  sell  the  cotton  to 
the  large  manufacturers.  When  they  get  the  money  the  money 
comes  back  to  us. 

Q.  In  London  the  joint-stock  banks  usually  pay  interest  at 
about  i  y*  per  cent,  below  the  bank  rate.  In  the  country  they 
have  to  pay  more.  What  is  the  custom  here? 

A.  There  is  no  strict  rule.  The  bank  rate  is  now  4  per 
cent,  and  we  allow  il/>  per  cent,  on  call  money.  In  the  in- 


534  THE  GERMAN  BANKING  SYSTEM 

terior  our  branches  allow  a  little  more.  It  is  the  same  as  in 
England. 

Q.  Does  the  bank  rate  influence  your  rate  for  discounts? 

A.  Yes;  we  are  influenced.  The  bank  rate  is  now  4  per 
cent,  and  our  private  discount  rate  is  2.^/2  per  cent. 

Q.  If  a  mercantile  customer  came  with  a  four  months'  bill 
satisfactory  in  character,  what  would  be  the  rate  to  him  ? 

A.  We  have  no  fixed  rate.  It  depends  upon  the  man  and 
the  bill. 

Q.  How  do  you  invest  your  surplus  funds  when  you  have 
no  demand  from  customers  ? 

A.  We  buy  bills  in  the  open  market,  or  accept  offerings  made 
to  us  from  houses  desiring  to  borrow. 

DRESDNER  BANK 

INTERVIEWS  WITH  HERR  SCHUSTER  AND  HERR  NATHAN", 
DIRECTORS  OF  THE  DRESDNER  BANK  * 

Q.  What  is  the  date  of  your  organisation? 

A.  1872. 

Q.  In  practice,  you  and  all  other  banks  endeavour  to 
employ  all  available  funds? 

A.  Yes;  we  only  carry  in  the  Reichsb^pk  and  other 
sufficient  cash  for  the  conduct  of  business^! 

Q.  You  regard  your  item  "  Bills  discoufWSP^  as^ffie  of 
practical  reserve? 

A.  Yes ;  it  is  immediately  convertible  into  cash  at  the  Reich- 
bank. 

Q.  Referring  to  the  item  "  Shares  in  other  banks,"  $6,662,- 
753,  do  you  control  all  banks  in  which  you  have  any  interest  ? 

A.  Yes;  practically.  We  probably  have  not  the  majority 
of  the  stock  in  any  bank;  but  our  holdings  are  sufficiently 
large  to  give  us  control. 

Q.  Is  the  tendency  toward  bank  consolidation?  Are  the 
smaller  banks  becoming  more  closely  affiliated  with  the  larger 
banks  ? 

A.  Yes ;  because  it  serves  a  mutual  advantage.  The  smaller 
bank  needs  better  facilities  to  take  care  of  the  increasing  busi- 

1 /feu/.,  pp.  392-418. 


THE  DRESDNER  BANK 

ness.  If  a  bank  wants  to  increase  its  capital,  and  the  share- 
holders do  not  care  to  subscribe  for  the  increase,  the  new  shares 
are  frequently  offered  to  us.  We  look  out  for  the  business  of 
these  banks  in  the  centres  and  give  them  participations  in  some 
of  our  important  undertakings. 

O.  In  Great  Britain  \ve  found  that  banking  interests  were 
practically  controlled  by  from  15  to  20  large  banks.  Does  that 
condition  prevail  in  Germany  ? 

A.  No;  but  the  tendency  is  in  that  direction.  One  differ- 
ence between  the  banks  of  England  and  Germany  is  this  —  in 
England  the  primary  purpose  of  the  banks  seems  to  be  to  se- 
cure large  earnings  for  their  shareholders.  In  Germany  our 
banks  are  largely  responsible  for  the  development  in  the  Em- 
pire, having  fostered  and  built  up  its  industries. 

Q.  Would  it  be  any  reflection  upon  a  bank  if  it  should  go 
to  the  Reichsbank  for  discounts  or  loans  in  easy  times  ? 

A.  No ;  we  seldom  go  in  easy  times,  however,  because  there 
is  no  need  of  our  doing  so. 

Q.  Is  there  strong  competition  between  the  important  banks 
of  Berlin  or  do  they  work  more  or  less  together? 

A.  Of  course  there  is  strong  competition  between  the  large, 
important  banks,  but  there  is  no  lack  of  harmony,  and  they 
very  frequently  work  together  in  syndicate  operations.  While 
it  is  the  desire  and  endeavour  of  each  bank  to  build  up  its  busi- 
ness, it  must  be  recognised  that  each  institution  has  more  or 
less  its  own  field  of  operation,  which  is  in  a  measure  respected 
by  the  other  banks.  As,  for  instance,  the  Deutsche  Bank  has 
done  a  very  large  volume  of  business  with  Turkey,  and  busi- 
ness emanating  from  that  source  is  expected  to  and  naturally 
does  go  to  the  Deutsche  Bank,  while  another  institution  may 
have  been  largely  identified  with  Roumania,  or  another  with 
some  large  local  interest.  We  ourselves  are  recognised  as  rep- 
resenting the  Krupp  interest  and  have  just  recently  formed  a 
syndicate  to  finance  one  of  their  operations. 

Q.  Our  understanding  is  that  a  merchant,  a  customer  of 
yours,  may  arrange  with  you  for  a  credit  of,  say,  I'oo.ooo 
marks,  which  may  or  may  not  be  secured,  and  may  draw  a 
ninety-day  bill  upon  you  for  that  amount.  He  may  send  that 
bill  to  the  Deutsche  Bank  for  discount.  If  the  Deutsche  Bank 


'556  THE  GERMAN  BANKING  SYSTEM 

will  discount  it,  they  present  it  to  you  and  you  accept  it.  Will 
you  kindly  state  why  this  custom  prevails? 

A.  One  reason  is  that  it  makes  a  bill  which  is  acceptable  at 
the  Reichsbank  and  is  a  prime  bill.  We  receive  one-fourth  of 
I  per  cent.,  or  more,  for  our  acceptance,  and  the  Deutsche 
Bank,  or  any  other  bank  discounting,  invests  its  money  at  a 
rate  for  the  period.  It  might  be  that  we  would  prefer  to  give 
our  customers  a  cash  credit  rather  than  to  accept  his  bill,  in 
which  event  we  would  so  arrange. 

Q.  Then  this  practically  enables  you  to  sell  your  credit  with- 
out using  your  cash  ? 

A.  Yes. 

Q.  We  understand  this  is  the  usual  custom  in  Germany. 

A.  Yes. 

Q.  Is  it  not  a  fact  that  in  the  last  analysis  the  customer  who 
uses  the  money  usually  pays  more  than  the  bank  rate  —  that 
is,  would  it  not  cost  him,  in  such  a  transaction  to-day,  say  5  or 
6  per  cent.,  while  the  bank  rate  is  4  per  cent.  ? 

A.  Yes. 

Q.  Is  it  your  endeavour  to  reach  the  small  country  towns? 

A.  No.  ' 

Q.  In  the  United  States  we  have  brokers  who  handle  com- 
mercial paper,  and  many  of  the  banks 'purchase  it  to  employ 
their  surplus  funds.  In  London  we  found  discount  houses 
whose  sole  business  was  to  handle  paper  for  sale  to  banks  to 
employ  their  surplus  funds.  What  corresponds  to  that  agency 
in  Berlin? 

A.  In  Berlin  there  are  two  brokers  who  handle  prime  bills, 
but  they  are  not  an  important  factor. 

Q.  How  do  you  employ  your  surplus  funds? 

A.  We  buy  bills  in  the  market  or  through  these  brokers. 

O.  In  employing  your  surplus  funds  do  you  buy  any  other 
bills  than  those  which  the  Reichsbank  would  accept? 

A.  No. 

Q.  Would  you  consider  the  issue  of  taxed  notes  by  the 
Reichsbank  in  a  sense  an  evidence  of  an  abnormal  condition? 

A.  No;  on  the  contrary,  it  is  quite  normal.  Last  year  it 
happened  twenty-five  times. 

Q.  In  times  of  trouble  do  the  large  banks,  like  your  own,  the 


THE  DRESDNER  BANK  557 

Deutsche  Bank,  and  Disconto,  co-operate  with  the  Reichsbank 
in  an  endeavour  to  prevent  the  exportation  of  gold? 

A.  Yes.  Opinions  are  divided  as  to  whether  it  is  for  the 
good  of  our  country  to  do  so  or  not.  Last  year,  for  instance, 
many  people  asked  for  gold.  It  was  refused  at  first  in  some 
quarters;  later  we  shipped  freely. 

Q.  Are  you  members  of  the  stock  exchange? 

A.  All  banks  and  bankers  are  members  of  the  stock  ex- 
change. 

Q.  By  virtue  of  their  being  banks? 

A.  Yes ;  they  have  to  pay  a  tax  for  the  exchange. 

Q.  Are  the  seats  expensive? 

A.  No.  You  do  not  buy  a  seat.  There  is  no  limit  to  the 
number  of  people  admitted.  We  have  from  twenty  to  thirty 
people  go  to  execute  our  orders. 

BANK  DES  BERLINER  KASSEN-VEREINS 
INTERVIEW  WITH  HERR  HOPPENSTEDT  l 

Q.  When  was  this  bank  organised? 

A.  In  1823,  under  the  general  companies  act. 

Q.  What  are  its  particular  functions? 

A.  This  bank  might  be  called  strictly  a  clearing  bank.  It 
clears  transactions  made  on  the  stock  exchange  and  also  cheques 
on  banks  which  do  not  clear  through  the  Reichsbank  Clearing 
House.  As  you  know,  our  banks  do  a  large  stock  exchange 
business.  It  is  their  custom  to  send  to  us  all  securities  sold 
to  others  clearing  through  us  with  a  list  of  the  purchasers. 
We  charge  the  purchasers  the  amounts  due  from  them  and 
credit  the  amounts  received  from  them,  balancing  every  night. 
The  securities  are  delivered  to  the  various  purchasers.  Some 
settlements  are  made  daily  and  others  monthly.  A  large  vol- 
ume of  cheques  and  bills  are  also  cleared.  This  is  simply  a 
clearing  business. 

Q.  You  show  loans  and  discounts  in  your  statement.  What 
is  the  character  of  these? 

A.  We  invest  our  funds  in  first-class  loans  and  prime  bills. 

Q.  Is  this  bank  owned  by  the  other  banks? 

llbid.f  pp.  486,  487. 


558  THE  GERMAN  BANKING  SYSTEM 

A.  It  is  partly  owned  by  other  banks.  There  is  also  a  com- 
mission of  shareholders  of  the  bank,  among  whom  are  the  first 
banks  of  our  city.  These  are  members  of  our  board. 

Q.  Is  it  the  custom  for  all  banks  which  clear  through  you 
to  have  a  balance  in  order  to  facilitate  the  payment  of  debits 
through  clearing  ? 

A.  Yes. 


CHAPTER  XXVI 
BANKING  IN  SOUTH  AMERICA 

1  THE  special  interest  in  South  American  banking  which  ex- 
ists at  this  time  is  the  product  of  at  least  four  distinct  factors: 

First.  It  has  been  evident  for  some  years  that  the  trade  be- 
tween North  and  South  America  is  rapidly  developing.  In 
the  ten  years,  1903-1913,  the  exports  from  the  United  States 
to  the  ten  Republics  of  South  America  increased  274  per  cent, 
against  an  increase  of  all  our  exports  during  the  same  period 
of  73  per  cent.  In  spite  of  inexperience,  crude  methods,  lack 
of  banks  and  of  ships  we  have  made  notable  gains  in  South 
American  trade.  There  seems  to  be  no  reason  to  question  the 
probability  of  a  continued  rapid  increase  during  the  next  few 
years. 

OUR  GROWING  SURPLUS  FOR  FOREIGN  INVESTMENT 

Second.  Other  forces  have  gradually  been  bringing  this 
country  more  and  more  into  the  position  of  looking  for  invest- 
ment opportunities  abroad.  While  it  is  true  that  the  United 
States  is  a  debtor  nation  in  the  sense  that  a  large  amount  (esti- 
mated at  $3,000,000,000  to  $6,000,000,000)  of  European  capi- 
tal is  invested  here,  it  is  also  true,  on  the  other  hand,  that  the 
national  income  has  for  some  years  been  sufficient  to  meet  an- 
nual payments  abroad,  to  make  large  fresh  investments  in  our 
own  enterprises,  and  still  to  leave  a  considerable  surplus  for 
investment  in  neighbouring  countries.  It  is  estimated  that 
American  capital  in  Mexico  and  Canada  amounts  approxi- 
mately to  $1,500,000,000.  In  South  America  there  are  already 
American  investments  of  perhaps  $300,000,000  to  $400,000,- 
ooo. 

1  Adapted  from  William  H.  Lough,  Banking  Opportunities  in  South 
America,  Department  of  Commerce,  Special  Agents  Series,  No.  106. 
Washington.  1915. 

559 


560  BANKING  IN  SOUTH  AMERICA 

As  the  national  income  and  savings  expand  and  as  the  op- 
portunities for  exceptionally  profitable  investment  within  this 
country  decrease,  it  is  clear  that  there  must  be  a  stronger  and 
stronger  tendency  toward  investment  abroad.  The  immense 
sums,  for  instance,  that  have  been  flowing  into  railroad  con- 
struction and  rebuilding  will  not  be  needed  to  so  great  an  ex- 
tent in  future.  A  considerable  proportion  of  this  overflow  of 
capital  may  certainly  be  expected  to  spread  into  South  America. 

GREATER  LENDING  POWER  OF  BANKS 

Third.  The  adoption  of  the  federal  reserve  system  has 
made  a  remarkable  improvement  in  the  handling  of  gold  and 
of  credit.  It  has  released  and  made  available  for  other  forms 
of  financing  great  sums  which  were  formerly  tied. up  in  scat- 
tered reserves.  We  have  only  to  look  at  the  monetary  history 
of  the  German  Empire  during  the  last  forty  years  to  see  how 
powerful  an  influence  on  industry,  trade,  and  investment  is 
exerted  by  the  centralisation  and  control  of  bank  reserves. 
The  London  Statist  has  calculated  the  ultimate  increased  lend- 
ing power  of  American  banks,  under  the  federal  reserve  sys- 
tem, at  $3,000,000,000. 

EUROPEAN  WAR 

Fourth.  The  European  war  has  suddenly  stimulated  the 
tendencies  which  were  previously  evident.  It  has  temporarily 
cut  off  a  considerable  amount  of  European  trade  in  South 
America,  thus  leaving  an  opening  for  even  more  rapid  develop- 
ment of  our  trade  than  would  otherwise  have  taken  place.  It 
has  deprived  South  America  for  a  period  of  several  years  of 
the  steady  inflow  of  European  capital.  It  has  enormously  in- 
creased the  exports  and  decreased  the  imports  of  this  country, 
thus  placing  suddenly  at  our  disposal  greatly  enlarged  financial 
power,  possibly  as  much  as  $1,000,000,000  per  annum  above 
normal.  Its  ultimate  effect,  we  may  safely  assume,  must  be 
to  increase  considerably  rates  of  interest  the  world  over,  thus 
stimulating  the  tendency  toward  an  enlarged  outflow  of  capital 
from  the  United  States  into  neighbouring  countries. 

By  reason  of  the  war  the  same  kind  of  a  situation  that  would 


ENGLISH  BANKS  IN  SOUTH  AMERICA  561 

otherwise  have  developed  slowly  in  a  period  of  years  now 
confronts  us  suddenly  when  \ve  are  as  yet  in  a  state  of  financial 
unpreparedness.  The  new  machinery  provided  by  the  federal 
reserve  act  is  not  yet  fully  utilised  or  adjusted  in  its  final  form. 
It  will  require  careful  study,  combined  with  prompt  action,  to 
utilise  the  financial  opportunities  now  before  us  with  greatest 
advantage  to  all  concerned. 

ENGLISH  BANKS  IN  SOUTH  AMERICA 

Although  English  interests  have  share  holdings  in  other  in- 
stitutions, there  are  only  five  banks  in  South  America  that 
stand  out  as  unmistakably  British.  In  the  order  of  their  de- 
velopment, these  are  the  London  and  River  Plate,  London  and 
Brazilian,  British  Bank  of  South  America,  Anglo-South  Amer- 
ican Bank,  and  Commercial  Bank  of  Spanish  America.  Each 
institution,  with  one  exception,  has  concentrated  on  one  coun- 
try, in  which  it  has  established  most  of  its  branches  and  to 
which  it  has  devoted  its  first  efforts.  The  exception  is  the 
British  Bank  of  South  America,  which  has  followed  the  con- 
trary policy  of  having  only  a  few  branches  strategically  lo- 
cated in  important  cities;  in  other  words,  this  bank  has  con- 
centrated on  selected  cities  rather  than  on  a  given  territory. 

ENGLISH   TRADE   AND   BANKS   DEVELOP   TOGETHER 

The  development  of  commercial  banking  by  British  inter- 
ests has  everywhere  gone  hand  in  hand  with  the  development 
of  British  investment  and  British  trade.  The  accounts  of  the 
railways,  mercantile  firms,  steamship  lines,  public  utilities,  and 
other  enterprises  conducted  by  their  fellow  countrymen  form 
the  great  bulk  of  the  business  of  the  four  leading  institutions; 
the  Commercial  Bank  of  Spanish  America  is,  however,  operat- 
ing under  different  conditions.  Indeed,  it  may  even  be  said  — 
again  speaking  in  broad  terms  —  that  the  English  banks  have 
made  comparatively  little  effort  to  secure  the  accounts  of  do- 
mestic enterprises.  It  is  certainly  safe  to  say  that  they  have 
not  made  efforts  in  this  field  at  all  comparable  with  the  efforts 
of  the  German,  Spanish,  French,  and  Italian  banks.  It  is 
interesting  to  note  also  in  this  connection  that  the  management 


562  BANKING  IN  SOUTH  AMERICA 

and  even  the  clerical  force  are,  with  few  exceptions,  brought 
over  from  England.  After  more  than  fifty  years  the  three 
leading  institutions  remain  as  distinctively  British  as  they  were 
at  the  beginning. 


GERMAN  BANKS  IN  SOUTH  AMERICA 

To  understand  the  energetic  development  of  German  banks 
in  South  America  during  the  last  forty-five  years  we  must 
consider  the  conditions  prevailing  in  Germany  during  that 
period  and  the  strong  forces  working  toward  industrial  and 
banking  expansion. 

Beginning  immediately  after  the  Franco-Prussian  War  of 
1870-71,  German  industrial  interests,  with  the  strong  support 
of  the  German  Government,  began  to  struggle  more  vigorously 
and  more  effectively  than  ever  before  for  a  larger  share  of 
trade  in  international  markets,  particularly  in  the  Far  East 
and  in  South  America.  It  was  clearly  realised  that  Germany 
needed  a  large  and  rapidly  growing  export  trade  in  order  to 
maintain  her  own  prosperous  development.  In  order  to  get 
this  trade  it  was  necessary  to  follow  a  definite  programme 
which  included  the  provision  of  better  shipping  facilities  and 
of  better  facilities  for  financing.  Up  to  that  time  Germany 
had  been  fully  as  dependent  as  the  United  States  is  to-day  upon 
foreign  ships  and  foreign  banks. 

It  was  also  clearly  realised  that  the  tendency  was  toward 
large  scale  production  in  most  industries  and  that  those  con- 
cerns which  could  secure  large  sales  in  the  world-wide  markets 
would  soon  come  to  enjoy  an  overwhelming  advantage  over 
smaller  competitors.  The  German  industries,  in  conjunction 
with  the  great  German  banks,  began  to  follow,  therefore,  a 
programme  of  concentration,  which  has  since  gone  steadily 
forward. 

These  two  forces  —  expansion  in  foreign  markets  and  con- 
centration at  home  —  have  had  a  controlling  influence  on  Ger- 
many's foreign  trade,  and  incidentally  on  her  foreign  banking. 


GERMAN  BANKS  IN  SOUTH  AMERICA  563 

OTHER   INFLUENCES  IN   BANK   EXPANSION 

Another  influence  of  importance  is  the  fairly  well-marked 
division  of  German  industrial  interests  into  a  small  number 
of  groups,  each  one  of  which  centres  about  and  is  allied  to  one 
of  the  great  banks.  To  some  extent  this  is  true  in  other  coun- 
tries, especially  where  banking  is  centralised  —  notably  in 
Canada,  for  instance  —  but  it  is  especially  clear  and  well  rec- 
ognised in  Germany.  Hence  each  one  of  the  great  banks  is 
under  especially  strong  pressure  to  foster  and  develop  the  in- 
terests of  its  important  clients,  even  at  the  expense  of  some 
temporary  risk  or  sacrifice  for  itself.  This  is  doubtless  the 
primary  motive  which  has  induced  the  great  German  banks 
one  after  another  to  enter  foreign  fields. 

There  is  a  wide-spread  notion  outside  Germany  that  the 
German  Government  has  itself  actively  intervened  for  the  pur- 
pose of  stimulating  foreign  trade  expansion  and  has  brought 
pressure  to  bear  on  German  banking  interests,  leading  them 
to  push  ahead  more  rapidly  than  their/ private  business  inter- 
ests would  have  required.  This  idea  may  or  may  not  be  cor- 
rect ;  so  far  as  the  writer  is  aware  there  is  no  special  evidence 
pertaining  to  South  American  banking  development  to  sustain 
it.  At  any  rate,  it  is  easy  to  explain  the  policy  of  these  banks 
as  being  based  upon  purely  business  considerations. 

As  a  matter  of  fact,  there  has  probably  been  much  exag- 
geration of  the  thought  that  the  German  banks  are  primarily 
self-sacrificing  instruments  of  an  ambitious  national  pro- 
gramme rather  than  ordinary  business  enterprises.  The  state- 
ment is  frequently  repeated  that  the  English  banks  in  South 
America  aim  first  and  all  the  time  for  profits,  while  the  Ger- 
man banks  aim  for  development  of  their  national  interests. 

Of  the  four  large  German  banks  in  South  America  only  one 
is  remarkable  for  energetic  and  successful  expansion.  The 
others  have  been  moderately  successful.  The  difference  is  to 
all  appearances  chiefly  due  to  management. 

Although  these  four  banks  were  presumably  designed  pri- 
marily to  advance  the  business  interests  of  the  banks  which 
organised  them,  they  have  incidentally  had  a  powerful  influ- 
ence on  investment  of  capital  and  on  trade.  The  German 


564  BANKING  IN  SOUTH  AMERICA 

manufacturers  of  machinery,  steel  products,  and  the  like,  have 
been  especially  helped  by  the  ability  of  the  German  banks,  both 
in  South  America  and  at  home,  to  help  in  finding  capital  and 
in  financing. 

The  German  banks  have  not  found  political  or  economic 
conditions  in  South  America  which  were  insuperable  obstacles 
to  sound  or  profitable  banking. 

OTHER  BANKING  INSTITUTIONS 

Other  nationalities  besides  the  English  and  the  Germans 
have  invaded  the  banking  field  in  South  America.  The 
French,  the  Italians,  and  the  Spanish  have  all  been  active,  par- 
ticularly on  the  east  coast,  and  are  represented  by  large  insti- 
tutions. 

AMERICAN   BANKS 

Only  after  the  federal  reserve  act  went  into  force  in  Novem- 
ber, 1914,  was  it  possible  for  any  bank  organised  under  the 
national-bank  act  of  the  United  States  to  establish  branches 
abroad.  The  act  restricts  this  privilege  to  institutions  having 
capital  and  surplus  of  $1,000,000  or  more,  and  gives  the  Fed- 
eral Reserve  Board  discretion  to  withhold  its  consent.  Up  to 
this  writing  the  only  institution  which  has  taken  advantage  of 
the  powers  granted  by  the  federal  reserve  act  to  enter  South 
America  is  the  National  City  Bank  of  New  York,  which  has 
established  branches  in  Buenos  Aires,  Montevideo,  Rio  de 
Janeiro,  Santos,  and  Sao  Paulo.  Other  branches  will  prob- 
ably be  established  in  the  near  future.  Especial  attention  is 
being  given  to  the  collection  of  credit  information.  The  bank 
also  maintains  a  foreign  trade  department,  which  gives  infor- 
mation and  advice  to  its  depositors  as  to  building  up  business 
abroad.  This  department  is  now  equipped  to  make  specific 
reports  on  trade  openings  in  Argentina,  Uruguay,  Brazil, 
Colombia,  and  Venezuela. 

The  Buenos  Aires  branch,  which  was  the  one  first  estab- 
lished, is  understood  to  have  done  a  satisfactory  amount  of 
exchange  business.  It  stood  ninth  in  volume  of  clearings  in 
January,  1915,  among  the  twenty-odd  commercial  banks  of 


DOMESTIC  BANKS  565 

that  city.  The  other  branches  have  not  been  in  operation  long 
enough  to  show  clear  results.  The  branches  in  Argentina  (in- 
cluding the  subbranch  at  Montevideo)  and  Brazil  have  each 
$1,000,000  allocated  to  them  —  though  this  is  purely  formal, 
as  the  bank's  whole  capital  and  surplus  are  behind  the  obliga- 
tions of  every  branch. 

The  expansion  of  the  National  City  Bank  in  South  America 
has  been  much  more  rapid  than  that  of  any  preceding  institu- 
tions, including  even  the  aggressive  German  banks.  As  a 
natural  result,  there  is  apparently  less  effort  at  this  stage  to 
build  up  local  connections  and  influence  in  each  city.  So  far 
the  policy  of  the  National  City  Bank  appears  to  be  to  furnish 
foreign  trade  facilities  to  American  exporters  over  as  wide  a 
territory  as  possible,  rather  than  to  concentrate  its  activities 
in  any  restricted  region. 

Other  national  banks  in  this  country  are  known  to  be  de- 
sirous of  aiding  in  the  financing  of  foreign  trade,  but  have  not 
up  to  this  time  found  it  practicable  to  take  action  under  the 
provisions  of  the  banking  law  as  it  now  stands. 

DOMESTIC   BANKS 

There  are  many  important  and  successful  banks  in  South 
American  countries  which  are  strictly  domestic  institutions, 
not  only  incorporated  under  the  laws  of  the  country  in  which 
they  do  business,  but  owned  and  managed  by  local  interests. 
The  notion  sometimes  seriously  put  forward  that  South  Amer- 
ican banking  is  almost  wholly  in  the  hands  of  foreigners  is 
quite  unfounded.  It  is  true  that  trading  operations  are  gen- 
erally handled  either  by  foreign  houses  or  by  houses  in  which 
there  is  a  strong  foreign  influence  and  that  the  financing  of 
nearly  all  foreign  trade  and  of  much  local  trade  is  likely  to  go 
to  foreign  banks.  But  the  accounts  of  the  rest  of  the  domestic 
trading  firms,  of  land  owners,  and  of  governmental  corpora- 
tions, as  a  rule,  gravitate  toward  the  domestic  banks. 

Following  is  an  approximate  statement  of  the  total  of  de- 
posits and  credits  in  account  current  in  each  South  American 
country  on  or  about  December  31,  1913,  and  an  estimate  of 
the  distribution  between  foreign  and  domestic  institutions : 


'566 


BANKING  IN  SOUTH  AMERICA 


Countries. 

Total  bank 
deposits. 

In 
European  bank's. 

In 
domestic  banks. 

Brazil    

$190,000,000 
42,500,000 
626,000,000 
3,500,000 

Amount. 

$78,000,000 
14,000.000 
173,000,000 

Per 
cent. 
40 

33 

28 

Amount. 

$112,000,000 
28,500,000 
453,000,000 
3,500,000 

Pei- 
cent. 
60 
67 

72 
100 

Uruguay    . 

Argentina   

Paraguay    

Total,  east  coast  

862,000,000 

104,500,000 
8,800,000 
28,500,000 
4,000,000 

265,000,000 

29,500,000 
1,500,000 
7,500,000 

30 

28 

17 
26 

597,000,000 

75,000,000 
7,300,000 
21,000,000 
4,000,000 

70 

72 

83 

74 

100 

Chile  

Bolivia  

Peru  

Ecuador    
Total,  west  coast   .... 
Colombia    

145,800,000 

5,800,000 
6,200,000 

38,500,000 

26 

107,300,000 

5,800,000 
6,200,000 

74 

IOO 
IOO 

Venezuela     

Total,  north  coast  .... 
Total,  South  America 

12,000,000 
1,019,800,000 

12,000,000 
716,300,000 

IOO 

70 

303,500,000 

30 

The  great  Banco  de  la  Nacion  Argentina  (Bank  of  the  Ar- 
gentine Nation)  is  an  official  institution,  all  the  shares  of  which 
are  owned  by  the  National  Government.  It  is  a  successor  of 
the  former  national  bank,  which  was  driven  into  insolvency 
in  the  great  financial  crisis  of  1890  and  was  afterwards  liqui- 
dated. Although  it  was  organised  during  a  period  of  disaster 
and  there  were  many  prophecies  of  its  certain  failure,  the  Bank 
of  the  Argentine  Nation  has  had  a  wonderful  development 
and  to-day  ranks  as  the  seventeenth  in  size  among  the  great 
banks  of  the  world. 

The  bank  pays  no  dividends,  but  carries  50  per  cent,  of  its 
profits  to  the  credit  of  capital  account  and  50  per  cent,  to  re- 
serves. Entirely  through  this  process  the  capital  and  reserve 
funds  have  increased  from  approximately  $22,000,000  in  1892 
to  over  $100,000,000  at  the  present  time.  During  the  same 
period  deposits  have  grown  from  $21,000,000  to  $205,000,000, 
and  discounts  and  advances  from  $47,000,000  to  $208,000,000. 
There  are  now  more  than  150  branches. 

The  bank  differs  from  most  other  governmental  institutions 
in  that  it  carries  on  distinctly  a  commercial  banking  business 
more  or  less  in  competition  with  private  commercial  banks. 


DOMESTIC  BANKS  567 

Until  the  crisis  of  1914  it  did  no  rediscounting  for  other 
banks,  and  even  during  the  crisis  its  activities  in  assisting 
other  banks  were  much  restricted. 

LAND   MORTGAGE   BANKS 

In  several  of  the  South  American  countries  there  is  a  well- 
organised  system  of  land-mortgage  banks  following  European 
models.  In  some  cases  the  banks  are  owned  and  operated  by 
the  National  Government  and  in  other  cases  receive  some  spe- 
cial support  or  guarantee.  The  plan  under  which  they  all 
operate  is  the  following:  The  owner  of  land  who  desires  to 
raise  money  on  mortgage  approaches  the  bank  and  requests  an 
investigation  and  appraisal,  the  expenses  of  which  he  usually 
pays.  If  the  property  is  shown  to  be  unencumbered  with  prior 
claims  and  meets  other  conditions,  the  bank  delivers  to  the 
owner  the  mortgage  bonds  in  convenient  denominations  up  to 
a  given  proportion,  usually  50  per  cent.,  of  the  appraised  value. 
These  mortgage  bonds  are  part  of  a  series  and  are  themselves 
secured,  not  by  any  specific  piece  of  property,  but  by  all  the 
property  covered  by  the  series ;  they  are  also  backed  by  the 
credit  of  the  issuing  bank.  The  owner  of  the  property  then 
offers  the  bonds  for  sale  through  a  broker,  and  in  this  way 
obtains  the  desired  funds.  He  pays  the  bank  a  small  commis- 
sion, from  one-fourth  of  I  per  cent,  to  I  per  cent.,  for  its 
services. 

In  Argentina,  where  this  system  is  developed  to  its  highest 
extent,  these  land-mortgage  bonds  are  known  as  "  cedulas," 
and  are  issued  by  the  Banco  Hipotecario  Nacional  (National 
Land  Mortgage  Bank).  At  the  present  time  the  Argentine 
"  cedulas  "  tend  to  sell  on  a  7  per  cent,  basis,  more  or  less. 

Uruguay,  Brazil,  and  Chile  all  have  similar  issues,  which 
sell  on  bases  ranging  from  7  to  9  per  cent,  or  even  higher. 
Broadly  speaking,  and  without  attempting  to  assign  a  definite 
value  to  any  one  of  these  issues,  they  are  sound,  conservatively 
issued,  well  protected,  and  under  normal  conditions  readily 
marketable.  The  more  important  issues  have  been  widely  sold 
in  England,  France,  and  Belgium.  If  they  were  properly  in- 
troduced and  made  well-known  in  the  United  States,  there  is 
no  reason  to  question  their  finding  a  good  market  here  also. 


568  BANKING  IN  SOUTH  AMERICA 

Side  by  side  with  the  land-mortgage  banks  there  are  operat- 
ing in  the  Argentine  a  number  of  English  mortgage  companies, 
which  directly  invest  their  own  funds  in  land  mortgages  and 
have  earned  highly  satisfactory  profits. 

In  several  countries  there  are  state-owned  savings  banks,  a 
large  portion  of  the  funds  of  which  also  go  into  land  mort- 
gages. 

CONDITIONS  OF  COMMERCIAL  BANKING 

A  banking  business,  like  any  other,  must  adapt  itself  to  sur- 
rounding conditions,  including  laws,  business  customs,  prece- 
dents created  by  older  banks,  and  the  like.  In  South  America 
these  conditions  differ  in  a  number  of  respects  from  those 
which  prevail  in  the  United  States.  Probably  the  first  im- 
pression of  most  observers  gives  an  exaggerated  idea  of  the 
differences.  However,  they  should  be  fully  and  carefully  con- 
sidered. 

The  chief  differences  that  directly  affect  banking  operations 
are  the  following:  (i)  Comparative  absence  of  banking 
regulation  on  the  part  of  governments  or  associations;  (2) 
national  colonies;  (3)  social  character  of  business  relations; 
(4)  lack  of  highly  developed  economic  organisation;  (5)  rela- 
tively high  and  stable  rates  of  interest;  and  (6)  in  some  coun- 
tries fluctuating  currencies.  The  first  five  of  these  circum- 
stances call  for  brief  comment. 

T 

LITTLE   CONTROL   OR   CO-OPERATION 

Not  only  is  there  a  marked  absence  of  laws  directly  applica- 
ble to  banking  concerns,  but  there  is  also  an  equally  noteworthy 
absence  of  control  exercised  either  by  the  Government  or  by 
associations  among  the  banks.  Even  the  large  governmental 
or  semi-governmental  banks  in  Brazil,  Uruguay,  Argentina, 
Chile,  and  Bolivia  are  competitive  with  the  other  banks. 
Whatever  influence  they  exercise  is  secured  through  their  active 
and  direct  competition,  not  through  any  special  authority  over 
the  other  banks  conferred  upon  them.  In  the  fall  of  1914, 
for  the  first  time,  there  was  some  rediscounting  of  the  paper 
held  by  other  banks  on  the  part  of  the  Bank  of  the  Argentine 


BANKING  CONDITIONS  569 

Nation  and  of  the  Bank  of  the  Republic  of  Uruguay;  but  this 
tendency  did  not  go  far.  The  other  banks  objected  to  placing 
information  as  to  their  relations  with  customers  in  the  hands 
of  the  governmental  institutions.  In  other  countries  there  has 
not  been  even  this  much  of  an  attempt  toward  fulfilling  the 
functions  of  a  central  bank  of  rediscount. 

It  is  difficult  to  secure  in  most  of  the  South  American  cities 
even  the  most  elementary  kind  of  co-operation  among  the 
banking  institutions.  How  is  it  possible  that  they  should  con- 
tinue to  stand  apart  when  they  would  obviously  gain  so  much 
by  coming  together?  A  partial  answer  is  to  be  found  in  the 
peculiarity  that  has  already  been  pointed  out,  namely,  the  fact 
that  many  of  the  more  powerful  institutions  are  the  offspring 
of  European  countries.  Each  one  is  fighting  to  support  the 
trade  of  a  certain  well-defined  group  of  clients.  The  national 
antagonisms  among  them  are  deep-seated  and  sometimes  viru- 
lent. All  this  was  true  even  before  the  European  war.  It 
will  be  tenfold  true  for  a  number  of  years  to  follow. 

NATIONAL   COLONIES 

This  leads  to  mention  of  the  second  condition,  one  which 
operates  in  favour  of  European-owned  banks  to  the  relative 
disadvantage  perhaps  of  American  banks.  This  condition  is 
the  presence  in  some  of  the  large  South  American  cities,  nota- 
bly Buenos  Aires,  of  a  large  colony  representing  each  one  of 
several  important  European  nations.  Naturally  the  tendency 
of  each  colony  is  to  support  banks  of  its  own  nationality. 

On  the  whole,  although  this  matter  of  national  affiliations 
is  undoubtedly  a  factor  to  be  reckoned  with,  it  appears  to  be 
by  no  means  decisive.  The  German  banks,  for  instance,  have 
been  able  to  expand  with  much  greater  rapidity  than  we  should 
have  been  justified  in  expecting  on  the  basis  of  their  national 
trade  and  national  colonies  alone.  This  is  true  likewise  of  the 
Italian  and  French  banks.  A  great  proportion  of  the  business 
men  of  South  America,  even  those  of  foreign  origin,  are  gov- 
erned less  by  their  national  sentiments  than  by  their  business 
interests. 


S70  BANKING  IN  SOUTH  AMERICA 


PERSONAL   CHARACTER   OF   BUSINESS   DEALINGS 

To  an  observer  accustomed  to  European  or  American  meth- 
ods, one  of  the  most  striking  features  of  business  life  in  the 
South  American  cities  is  its  strongly  personal  and  social  fla- 
vour. We  are  accustomed  in  this  country  to  emphasise  the 
principle  that  friendship  is  not  a  safe  guide  in  business  deal- 
ings. In  South  America  the  contrary  is  more  nearly  true. 
Family  ties  are  apt  to  be  a  controlling  factor  in  choosing  part- 
ners and  employes.  If  one's  ultimate  object  is  to  have  busi- 
ness dealings  with  a  firm,  he  must  first  cultivate  the  personal 
friendship  of  the  head  of  the  firm.  Social  relations  and  busi- 
ness relations  become  confused,  and  it  is  hopeless  to  expect  the 
purely  impersonal  view  of  a  business  proposition  that  is  con- 
sidered correct  in  this  country.  Like  all  sweeping  statements, 
this  one  is  subject  to  exceptions.  There  are  many  American, 
German,  and  English  firms,  especially  in  Buenos  Aires,  which 
prefer  what  we  denominate  "  business-like  methods,"  but  they 
are  not  numerous  enough  to  give  the  tone  to  business  life. 

This  is  a  condition  which  directly  affects  banking  practice. 
It  makes  it  very  difficult,  for  example,  to  introduce  the  custom 
of  securing  full  financial  statements  from  all  applicants  for 
credit.  The"  request  for  a  statement  is  apt  to  be  construed 
(as  was  the  case  in  this  country  not  many  years  ago)  as  a 
reflection  on  the  personal  honesty  and  credit  standing  of  the 
applicant.  For  the  same  reason  it  is  difficult,  and  may  fre- 
quently be  poor  policy,  for  a  bank  officer  to  ask  a  customer  a 
direct  question  as  to  the  status  of  his  business.  He  is  likely 
not  to  take  an  impersonal  attitude  toward  the  question,  but  to 
resent  it  as  if  it  were  an  attempt  to  pry  into  his  purely  personal 
affairs.  Consequently,  all  business  men,  including  bankers, 
are  forced  to  rely  to  a  great  extent  in  estimating  the  credit 
standing  of  individuals  and  firms  on  their  personal  impressions, 
on  such  information  as  they  are  able  to  secure  through  indirect 
hints  and  questions  and  on  the  business  gossip  which  they  pick 
up.  It  must  be  remembered  that,  except  for  Buenos  Aires, 
most  of  the  business  communities  are  comparatively  small  and 
isolated.  There  is  little  opportunity,  therefore,  for  long-con- 
tinued fraud.  A  man  who  shows  traces  of  dishonesty  is  much 


BANKING  CONDITIONS  571 

more  plainly  marked  than  in  larger  communities.  As  a  con- 
sequence, the  lack  of  the  machinery  and  the  customs  that  we 
consider  indispensable  in  extending  credit  does  not  prevent  the 
formation  of  correct  ideas  as  to  the  wealth  and  character  of  a 
business  man. 

UNDEVELOPED   ECONOMIC   ORGANISATION 

Most  of  the  South  American  countries,  we  should  keep  in 
mind,  are  still  sparsely  populated  and  have  no  need  for  the 
elaborate  machinery  of  trade  and  finance  which  exists  in 
Europe  and  North  America.  The  region  farthest  advanced 
in  its  economic  development,  the  River  Plate  Basin,  may  be 
roughly  compared  to  agricultural  States  like  Iowa,  Kansas, 
and  Nebraska  as  they  were  thirty  years  ago.  Farming  meth- 
ods are  usually  not  economical.  The  small  farmers  have  little 
money  of  their  own,  their  lands  are  heavily  mortgaged,  and 
they  are  "  carried  "  from  one  crop  to  another  by  the  local  gen- 
eral retailer,  who  makes  advances  to  them  both  in  goods  and 
in  money.  The  retailer  must  in  turn  secure  liberal  credits 
from  wholesalers,  who  are  in  their  turn  partly  "  carried  "  by 
the  banks.  There  is  no  clear-cut  distinction  between  dealers 
in  commodities  and  bankers,  for  the  dealers  are  forced  to 
finance  most  of  their  own  sales.  Such  an  arrangement  of 
course  favours  extravagant  credits,  high  prices,  speculation, 
and  crises,  just  as  it  did  in  the  United  States.  It  is  rapidly 
giving  way  to  a  more  complex  organisation,  in  which  the 
farmer  has  funds  of  his  own,  does  his  short-term  borrowing 
at  a  bank,  and  pays  cash  for  his  purchases. 

Without  attempting  to  comment  on  intermediate  grades  of 
organisation  we  may  consider  briefly  the  manner  in  which 
trade  and  finance  are  conducted  in  the  north  coast  countries. 
An  officer  of  a  bank  there  asserts  that  banking  in  the  north 
coast  countries  is  not  to  any  great  extent  a  matter  of  handling 
currency  or  money  funds.  The  intermediary  system  of 
brokers,  merchants,  and  other  middlemen  between  the  producer 
and  his  market,  to  which  we  are  accustomed,  is  lacking,  and 
the  banker  must  take  the  place  of  all  of  them.  He  must  him- 
self inspect  and  sell  produce.  Loans  are  made,  for  instance, 
secured  by  growing  crops ;  the  bank  sends  a  man  to  the  planta- 


572  BANKING  IN  SOUTH  AMERICA 

tion  to  look  over  the  coffee  or  cocoa,  or  whatever  the  crop  may 
be,  and  report  on  its  condition  and  prospects;  to  protect  itself 
the  bank  sees  that  it  is  properly  prepared  for  shipment,  and 
takes  care  of  the  sale  in  the  New  York,  London,  or  Hamburg 
market.  The  bank  collects  the  proceeds  and  credits  the  cus- 
tomer with  his  share.  Interest  rates  run  from  8  to  15  per 
cent,  and  commissions  for  selling  from  i  to  3  per  cent. 

INTEREST   RATES 

Interest  rates  average  considerably  higher  —  even  making 
allowance  for  increased  risk  —  in  South  America  than  in  the 
United  States.  They  are,  however,  much  more  stable  and 
more  uniform  over  the  whole  continent.  The  uniformity  is 
no  doubt  to  be  ascribed  chiefly  to  the  large  English  and  Ger- 
man banks,  with  their  branches  in  several  different  countries 
and  their  ready  access  to  European  financial  centres.  The 
stability  in  rates  over  a  period  of  years  is  presumably  due  in 
part  to  the  relatively  gradual  development  of  banking,  com- 
merce, and  production,  so  that  sudden  shifts  in  the  demand 
for  and  supply  of  banking  capital  are  not  frequent. 

There  are,  however,  a  number  of  exceptions  to  the  general 
stability.  In  Argentina  the  crop-moving  season  creates, 
though  to  a  much  smaller  extent,  the  same  kind  of  extra  de- 
mand for  currency  as  in  the  United  States,  and  tends  to  make 
some  seasonal  variations  in  discount  rates.  They  vary  from 
as  low  as  6  per  cent,  to  as  high  as  12  per  cent.,  but  do  not 
normally  move  far  from  8  or  9  per  cent. 

COMPENSATION   OF   DIRECTORATE 

The  German,  French,  Italian,  Spanish,  and  many  of  the 
domestic  banks,  especially  in  Argentina  and  Peru,  follow  the 
.European  custom  of  compensating  the  home  office  directorate 
by  allowing  them  a  fixed  percentage  of  the  net  profits.  The 
president,  manager,  founder,  and  others  may  also  be  com- 
pensated in  the  same  way.  The  net  profits  of  the  Banco 
Espanol  del  Rio  de  la  Plata  are  distributed:  2j4  per  cent,  to 
certain  specified  charities,  I  per  cent,  to  the  founder,  12  per 
cent,  to  the  reserve  fund,  2  per  cent,  to  the  directors  and  man- 
agers, 2^4  per  cent,  to  the  fund  for  employes,  80  per  cent,  to 


BUSINESS  OF  FOREIGN  BANKS  573 

the  shareholders  for  dividends  and  dividend  reserves;  those 
of  the  Banco  de  Italia  y  Rio  de  la  Plata:  */2  per  cent, 
to  charity,  5  per  cent,  to  the  reserve  fund,  7  per  cent,  to 
the  directorate,  il/2  per  cent,  to  the  fund  for  employes,  86  per 
cent,  to  the  shareholders.  There  is  apparently  no  general  rule 
which  governs  the  distribution  except  possibly  that  the  larger 
the  bank  the  smaller  is  the  percentage  for  the  directorate  and 
management.  In  England  the  directors  are  more  likely  to 
receive  a  fixed  compensation.  Whether  this  plan  of  having  a 
paid  directorate  works  better  than  the  American  method  of 
having  a  directorate  made  up  usually  of  some  of  the  larger 
shareholders,  whose  payment  is  purely  nominal,  is  an  open 
question.  It  is  largely  a  matter  of  national  custom. 

CLASSES   OF   BUSINESS  OF   FOREIGN   BANKS 

First.  The  foreign  banks  in  South  America  usually  start 
by  devoting  a  large  proportion  of  their  energy  and  capital  to 
operations  in  exchange. 

Second.  In  this  connection  they  purchase  and  make  ad- 
vances against  commercial  bills  drawn  on  importers  in  the 
countries  where  they  are  doing  business. 

Third.  At  the  same  time  the  home  office  in  London,  Ham- 
burg, or  Berlin  is  probably  developing  a  business  in  acceptances 
which  involves  comparatively  little  direct  expense  and  allows 
considerable  profits. 

Fourth.  All  South  American  banks  are  called  upon  to  han- 
dle collection  of  drafts  and  sometimes  to  take  care  of  ordinary 
mercantile  transactions,  both  on  a  commission  basis. 

Fifth.  An  activity  which  may  be  of  some  importance  from 
the  beginning  consists  of  underwriting  and  selling  securities. 

Sixth.  As  quickly  as  possible  the  foreign  banks  build  up  a 
local  account  current  and  loan  and  discount  business. 

Seventh.  Some  of  the  banks,  especially  the  German  banks, 
have  participations  in  syndicates  and  in  industrial  enterprises. 

Eighth.  In  some  branches  they  receive  money  and  securi- 
ties for  safekeeping  or  rent  safe-deposit  boxes. 

Ninth.  Many  banks  have  savings  and  mortgage-loan  de- 
partments. 

None  of  the  distinctively  foreign  banks  in  South  America 


574  BANKING  IN  SOUTH  AMERICA 

has  as  yet  issued  circulating  notes ;  this  is  being  done,  however, 
fey  some  of  the  domestic  banks  in  which  foreign  capital  is 
heavily  interested. 

There  may,  of  course,  be  other  miscellaneous  activities. 


CHAPTER  XXVII 
AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

WHILE  agricultural  credit  has  been  a  subject  of  intermittent  discus- 
sion in  the  United  States  for  almost  a  generation,  the  movement  has 
had  its  main  development  within  recent  years.  In  November,  1911, 
the  American  Bankers'  Association  created  a  committee  to  study  land 
and  agricultural  credit  at  home  and  abroad.  In  March,  1912,  Ameri- 
can ambassadors  and  ministers  were  instructed  by  the  State  Depart- 
ment to  gather  information  concerning  rural  credit  institutions  in 
Europe.  A  year  later  the  Southern  Commercial  Congress  also  insti- 
tuted a  careful  investigation.  These  acts,  and  reports  published  gave 
the  movement  a  national  character  and  scope. 

Several  states,  such  as  Massachusetts,  New  York,  and  Missouri, 
have  recently  made  legislative  provision  for  rural  credit  institutions 
and  during  the  last  two  years  very  numerous  bills  pertaining  to  rural 
credit  have  been  introduced  in  Congress.  It  seems  not  unlikely  that 
legislation  providing  for  the  establishment  of  a  federal  system  of  land 
banks  and  rural  credit  associations,  subsidized  by  the  Government,  will 
be  enacted  in  the  near  future. 

The  functions  and  work  of  rural  credit  institutions  in  Europe,  briefly 
discussed  in  the  first  two  selections  of  this  chapter,  are  treated  more 
fully  in  connection  with  the  chapters  on  the  banking  systems  of  Euro- 
pean countries,  notably  those  of  Germany  and  France. 

Various  European  nations,  with  soil  naturally  inferior  to 
ours,  have  established  agricultural  credit  and  thereby  have 
greatly  eased  the  burden  of  the  cost  of  living.  Hitherto  we 
have  lived  on  the  bountiful  overflow  of  our  rich  land,  and  the 
pinch  of  necessity  has  not  been  felt;  but  now  our  population 
has  grown  enormous,  our  standards  of  living  have  been  greatly 
raised,  and  our  land  is  showing  the  effect  of  generations  of 
taking  out  with  very  little  putting  back.  We  must  do  better 
or  suffer. 

By  the  installation  of  agricultural  credit,  farming  will  not 
only  be  made  more  profitable,  but  it  will  in  the  end  make  coun- 

1  Adapted  from  R.  B.  Van  Cortland,  What  is  Agricultural  Credit? 
North  American  Review,  Vol.  109,  April,  1914,  pp.  585-588. 

575 


5/6        AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

try  life  more  attractive.  The  banking  system  of  to-day  is 
adapted  to  the  needs  of  manufacture  and  commerce.  The 
processes  of  nature  are  so  much  slower,  however,  that  banking 
for  farmers  must  be  organised  on  a  basis  of  credit  for  much 
longer  periods. 

Our  present  system  of  borrowing  on  land  is  by  mortgages 
running  from  three  to  five  years,  the  entire  principal  coming 
due  at  one  time.  This  is  expensive,  involving  renewals,  and 
dangerous  from  the  possibility  of  the  mortgage  falling  due  at 
a  time  of  restricted  credit  so  that  it  cannot  be  renewed.  On 
the  continent  of  Europe  this  business  is  handled  by  so-called 
land-mortgage  banks,  or  rather  associations. 

The  mortgages  granted  are  pledged  for  the  security  of  bonds 
which  the  institution  issues  and  sells  in  the  general  market. 
These  bonds  have  no  fixed  maturity,  but  can  be  retired  at  par 
or  some  small  premium  at  any  time.  When  the  borrower 
mortgages  his  land  to  the  bank  he  agrees  to  pay  a  certain  fixed 
sum  semi-annually.  This  is  called  the  "  annuity  "  and  is  com- 
posed of  the  annual  interest  plus  an  amount,  generally  ^2  per 
cent,  toward  the  reduction  of  the  principal  of  the  debt  and 
known  as  "  amortisation,"  and  an  additional  amount,  about 
J4  per  cent.,  toward  the  expenses  of  the  bank.  The  borrower, 
therefore,  at  once  begins  to  extinguish  the  principal  of  the 
debt;  and  as  each  year  the  principal  decreases,  the  interest,  of 
course,  decreases  also,  and,  the  annuity  being  fixed,  the  pro- 
portion of  it  applicable  toward  the  extinction  of  the  mortgage 
increases.  Thus  it  happens  that,  beginning  with  a  payment 
of  }/2  per  cent,  toward  principal,  the  mortgage  bearing  4  per 
cent,  to  4^/2  per  cent.,  which  are  the  general  rates,  the  entire 
debt  is  extinguished  in  between  fifty  and  sixty  years. 

The  mortgaging  of  land  is  known  as  long-term  credit,  and 
it  may  be  handled  by  joint-stock  institutions  or  by  associations 
of  borrowers,  but  in  institutions  furnishing  the  credit  required 
by  farmers  for  working  capital,  such  as  the  purchase  of  seeds, 
fertilizer,  payment  for  labour,  etc.,  which  is  known  as  short- 
term  credit,  the  aim  that  the  borrower  should  be  primarily 
considered  rather  than  the  lender  assumes  fundamental  impor- 
tance. 

On  the  continent  of  Europe  a  solution  of  the  problem  of 


SHORT  TIME  CREDIT  57> 

short-term  credit  is  found  in  the  organisation  of  banks  by  the 
application  of  so-called  co-operative  principles.  The  purpose 
is  to  provide  organisations  in  which  the  borrower  receives  con- 
sideration rather  than  the  lender,  also  to  keep  the  money  of 
any  body  of  individuals  for  the  use  of  that  body.  Under  our 
present  system  a  great  deal  of  money  belonging  to  farmers 
finds  its  way  into  Wall  Street.  At  present  the  lenders  are 
organised;  whereas  the  borrower  stands  alone. 

AGRICULTURAL  CREDIT  CONDITIONS  IN  THE  UNITED 

STATES 

1  The  United  States,  although  the  leading  country  of  the 
world  in  the  amount  of  its  agricultural  products  and  in  the 
extent  of  its  banking  business,  is  behind  nearly  every  other 
progressive  country  of  importance  in  the  development  of  agri- 
cultural credit,  i.  e.}  short-time  non-mortgage  credit.  Our 
manufacturing  and  commercial  businesses  are  financed  largely 
by  means  of  such  credit,  and  the  capital  invested  in  these  in- 
dustries is  thereby  rendered  manifoldly  efficient;  not  so  with 
agriculture.  Most  farmers  apparently  make  little  or  no  use 
of  short-time  credit.  There  seems  to  be  a  wide  acceptance  in 
this  country  even  among  the  farmers  themselves  of  the  dictum 
of  Louis  XIV,  that :  "  Credit  supports  agriculture,  as  the  cord 
supports  the  hanged."  Is  this  a  correct  description  of  the 
situation?  If  so,  what  is  the  explanation,  and  what  remedies 
if  any  are  needed?  The  object  of  this  paper  is  to  throw  light 
upon  the  answers  to  these  questions. 

First,  as  to  existing  banking  facilities  for  agricultural  credit, 
and  their  utilization  by  farmers.  It  is  well  known  that  the 
banking  capital  of  the  country  is  concentrated  to  a  great  ex- 
tent in  our  large  cities  —  to  a  greater  extent  than  it  would  be 
if  we  had  a  well-developed  system  of  branch  banks  like  Canada 
—  and  that  the  banks  of  these  cities  are  prevented  by  reason 
of  their  location  from  making  many  agricultural  loans,  even  if 
they  were  so  inclined.  Of  the  7,301  national  banks  in  the 
United  States  September  i,  1911,  191  or  2.6  per  cent,  were 

*E.  W.  Kemmerer,  Agricultural  Credit  in  the  United  States,  The  Ameri- 
can Economic  Review,  Vol.  2,  No.  4,  December,  1912,  pp.  852-872. 


578       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

located  in  the  dozen  largest  cities  of  the  country.1  The  na- 
tional banks  of  these  twelve  cities,  representing  but  14  per  cent. 
of  the  population  of  the  country,  had  37  per  cent,  of  the  na- 
tional banking  capital  (capital,  surplus,  and  undivided  profits), 
33  per  cent,  of  the  individual  deposits,  and  40  per  cent,  of  the 
loans.  It  should  be  noted,  however,  that  since  the  act  of  1900, 
authorizing  the  establishment  of  national  banks  with  a  capital 
of  less  than  $50,000  in  small  towns,  there  has  been  a  continual 
and  rapid  increase  in  the  number  of  national  banks  in  small 
communities.  On  September  i,  1911,  out  of  the  total  7,301 
national  banks  there  were  1,966  with  a  capital  of  $25,000,  and 
therefore  presumably  located  in  towns  of  less  than  3,000  pop- 
ulation, 372  with  a  capital  between  $25,000  and  $50,000,  and 
therefore  presumably  in  to\vns  of  less  than  6,000  population, 
and  2,297  with  a  capital  between  $50,000  and  $1.00,000.  Ex- 
cept for  banks  in  towns  not  exceeding  6,000  population,  the 
law  as  amended  in  1900  does  not  permit  any  national  bank  to 
be  organized  with  a  capital  less  than  $100,000. 

Are  the  national  banks  which  are  accessible  to  farmers  in  a 
position  under  the  law  to  meet  farmers'  needs?  The  answer 
to  this  question  must  be  in  the  affirmative.  Aside  from  the 
fact  that  national  banks  are  not  permitted  to  make  loans  on 
real  estate  security,2  there  is  no  restriction  in  the  national  bank- 
ing act  which  would  interfere  with  loans  to  farmers  for  agri- 
cultural purposes.  Personal  security  alone  is  legally  accept- 
able ;  the  range  of  possible  collateral  security  is  practically  un- 
limited ;  and  there  is  no  limitation  fixed  by  law  as  to  the  period 
of  loans.  National  banks  therefore  have  a  very  free  hand  in 
regard  to  loans  to  farmers. 

When  we  inquire  concerning  agricultural  credit  in  banks 
under  state  charters  we  find  conditions  varying  with  the  differ- 
ent States,  but,  with  a  few  minor  qualifications,  it  may  be  said 
that  the  state  banking  laws  are  free  from  restrictions  that 
would  hamper  state  banks  and  trust  companies  in  extending 

1  New  York,  Chicago,  Philadelphia.  St.  Louis,  Boston,  Cleveland,  Balti- 
more, Pittsburgh,  Detroit,  San  Francisco,  Milwaukee,  and  Cincinnati.     For 
Buffalo,  the  tenth  city  in  population,  Cincinnati,  the  thirteenth  city,  was 
substituted,  since  for  Buffalo,  which  is  not  a  reserve  city,  satisfactory 
banking  figures  are  not  available. 

2  [National  banks  are  now  permitted  to  lend  on  real  estate  security  by 
the  Federal  Reserve  Act  passed  in  1913.] 


BANK  LOANS  TO  FARMERS  579 

credit  liberally  to  responsible  farmers.  They  are  in  a  much 
better  position  in  one  respect  to  deal  with  farmers  than  are 
national  banks,  that  is,  in  the  matter  of  accepting  real  estate 
security.  No  state  denies  state  banks  this  privilege,  and  such 
restrictions  as  exist  upon  its  exercise  are  generally  not  onerous. 

If  commercial  banks  are  comparatively  unhampered  by  law 
in  making  short-time  loans  to  farmers,  it  may  be  asked:  To 
what  extent  are  such  loans  made?  Unfortunately  practically 
no  information  is  available  on  this  question.  In  answer  to  an 
inquiry  the  Comptroller  of  the  Currency  wrote,  under  date  of 
May  27  of  this  year,  that  no  information  with  reference  to 
short-time  loans  made  to  farmers  by  national  banks  had  ever 
been  compiled  by  the  comptroller's  office.  The  writer  has 
found  no  trace  of  any  investigation  of  this  subject  by  state 
banking  departments.  For  about  a  year  he  has  taken  occa- 
sion to  inquire  at  every  opportunity  of  individual  bankers  con- 
cerning their  experience  with  regard  to  loans  to  farmers  in 
different  parts  of  the  country.  The  replies  received  are  so 
divergent  that  no  conclusion  can  be  drawn  from  them,  except 
that  the  practice  varies  widely  in  different  sections  of  the  coun- 
try and  even  in  different  communities  in  the  same  section,  and 
that  probably  the  farmers  of  the  North  Central  and  Western 
States  borrow  of  commercial  banks  more  than  do  those  of  the 
Eastern  and  Southern  States.  There  is  not  sufficient  evidence, 
however,  for  this  latter  inference  to  make  it  much  more  than 
a  guess.  In  the  absence  of  any  comprehensive  data,  I  shall 
resort  to  the  unsatisfactory  but  representative  replies  from 
different  parts  of  the  country. 

Neither  of  the  two  national  banks  in  the  city  of  Ithaca, 
N.  Y.,  makes  any  appreciable  amount  of  loans  to  farmers. 
Both  claim  to  be  willing  to  do  so,  but  say  there  is  practically 
no  demand.  In  some  of  the  neighboring  cities,  however, 
such  loans  by  national  banks  are  more  common.  The  cashier 
of  a  national  bank  in  a  town  of  about  800  population  in  an 
agricultural  section  of  northeastern  Pennsylvania  writes : 

Our  farmers  as  a  rule  are  not  large  borrowers  and  want  loans 
only  in  small  amounts  for  short  periods. 

Farmers  in  general  will  not  go  on  each  other's  paper  no  matter 
how  good  the  parties  are,  for  they  have  been  so  often  taken  in  by 


'580        AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

wild-cat  schemes  that  they  are  shy  when  their  names  are  required 
to  be  placed  upon  paper.  They  realize  also  that  they  are  not 
familiar  with  business  methods  in  the  commercial  world  and  dare 
not  trust  themselves. 

There  is  a  moderate  amount  of  borrowing  by  farmers  in 
western  New  Jersey.  Estimates  made  by  bankers  in  Prince- 
ton as  to  the  proportion  of  farmers  in  that  neighborhood  who 
borrow  for  short  periods  of  local  banks  vary  from  15  to  40 
per  cent. 

A  former  president  of  a  national  bank  in  Indianapolis 
writes : 

We  came  very  little  in  contact  with  farmers.  \Ve  made  special 
effort  to  secure  such  business  by  sending  to  a  considerable  mailing 
list  of  carefully  selected  farmers,  circulars  and  personal  letters  .  .  . 
but  the  business  did  not  come.  My  inference  was  that  they  dealt 
with  the  nearby  small  banks. 

Of  the  situation  in  Lafayette,  Indiana,  a  former  vice-presi- 
dent of  a  national  bank,  writes : 

About  50  per  cent,  of  our  business  was  with  farmers.  They  bor- 
row frequently  from  commercial  banks,  funds  to  be  used  for  crop 
planting,  crop  gathering,  purchase  of  agricultural  machinery,  im- 
provements on  the  farm,  purchase  of  cattle,  and  the  carrying  of 
cattle  or  hogs  to  maturity.  Through  Indiana  these  farmers'  loans 
are  very  usual  in  the  country  banks,  many  preferring  state  charters 
so  they  may  make  these  loans  not  only  on  personal  but  also  on 
mortgage  security. 

Farmers  are  seldom  able  to  give  any  but  personal  or  mortgage 
security.  A  large  percentage  of  them  are  sufficiently  responsible 
to  be  entitled  to  and  to  receive  reasonable  credit  without  security. 

Farmers  seem  to  endorse  for  each  other  much  more  readily  than 
do  those  of  other  classes.  .  .  .  The  reason  is,  I  think,  clear.  Each 
knows  pretty  much  everything  about  his  neighbor's  financial  status, 
the  amount  and  value  of  his  land,  his  live-stock,  and  other  visible 
personal  property,  the  amount  of  any  mortgage  and  when  due.  So 
much  being  thus  in  the  open  there  is  less  of  the  secretive  habit,  so 
that  the  extent  of  the  invisible  personal  property  and  debts  is  apt 
to  be  known. 

A  similar  report  comes  from  a  national  bank  in  Lincoln, 
Nebraska,  from  which  the  following  extracts  are  taken : 


BANK  LOANS  TO  FARMERS  581 

The  farmers  of  this  state  have  need  of  accommodations  of  this 
kind  to  carry  them  through  the  crop  season.  As  a  matter  of  fact, 
they  use  short-time  credit  to  fully  as  great  an  extent  as  do  the  busi- 
ness men  in  the  city  and  smaller  towns.  In  fact,  I  think  it  is  true 
that  in  the  smaller  towns  the  bankers  favor  the  farmers  in  prefer- 
ence to  the  small  business  men.  .  .  . 

There  is  no  doubt  about  the  average  well-to-do  farmer  in  this 
state  being  able  to  furnish  satisfactory  security  aside  from  mort- 
gaging his  farm  for  such  temporary  loans  within  any  reasonable 
limitations.  In  some  cases  the  banks  take  chattel  mortgages  on 
cattle  or  other  live-stock,  and  in  some  cases  where  the  farmer  has 
a  good  equity  in  his  farm  they  will  not  hesitate  to  take  his  personal 
note. 

While  I  do  not  know  that  there  is  any  particular  difference  be- 
tween farmers  and  other  classes  in  this  state  as  to  their  willingness 
to  go  security  for  each  other,  yet  very  little  of  this  is  done  any 
more.  There  was  a  time  when  it  was  not  an  uncommon  thing,  but 
it  has  become  less  and  less  until  now  there  is  very  little  signing 
done  for  others.  In  fact,  the  farmers  feel  that  they  are  able  to 
take  care  of  themselves  and  do  not  ask  others  to  sign  with  them, 
and  are  able  to  handle  themselves  without  such  an  endorsement. 
This  is  true  of  all  classes  in  this  state. 

I  have  never  felt  that  in  this  locality  farmers  suffered  in  any 
•way  from  lack  of  credit  facilities.  .  .  . 

A  former  bank  examiner  in  the  state  of  California,  himself 
a  farmer,  writes : 

The  farmers  of  California  do  not  to  any  considerable  extent  make 
a  practice  of  borrowing  money  from  local  banks  or  money  lenders 
for  short  periods.  .  .  . 

In  reviewing  the  various  bank  examiners'  reports  on  some  500 
state  banks  I  recall  very  few  instances  of  crop  mortgages,  and  it 
impresses  me  that  in  many  of  the  cases  the  mortgage  was  taken  to 
obtain  additional  security  for  loans  previously  granted  and  secured 
otherwise. 

I  think  it  would  be  safe  to  say  that  the  bankers  as  a  rule  have  not 
favored  short-time  unsecured  loans  to  farmers.  They  are,  how- 
ever, fast  awakening  to  the  fact  that  as  a  rule  these  are  the  safest 
loans  a  bank  can  make,  and  are  making  an  effort  to  get  in  closer 
touch  with  the  farmer.  It  would  also  be  safe  to  say  that  the 
average  small  farmer  does  not  as  yet  realize  that  he  can  obtain 
such  credit  at  a  bank. 

Our  farmers  as  a  class  are  exceedingly  reluctant  "  to  go  each 
other's  security."  Two-name  paper  is  mostly  confined  to  com- 
mercial transactions. 


582       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

A  college  professor  in  the  state  of  Washington  informs  me 
that  short-time  loans  to  farmers  are  common  in  that  state,  but 
that  frequently  the  rate  of  interest  charged  is  2  per  cent, 
higher  than  that  on  commercial  loans  —  the  explanation  com- 
monly given  being  that  a  farmer  borrowing  generally  reduces 
the  resulting  deposit  credit  more  rapidly  than  does  a  merchant. 

In  the  Southern  States,  particularly  in  the  cotton,  rice,  and 
tobacco  sections,  the  use  of  crop  liens  for  short-time  loans 
appears  to  be  much  greater  than  in  other  sections  of  the  coun- 
try.1 Such  meager  testimony  as  I  have  been  able  to  secure 
seems  to  show  that  the  amount  of  short-time  agricultural 
credit  extended  by  banks  in  the  South  is  relatively  small  but 
rather  rapidly  increasing.  The  banks  are  catering  more  and 
more  to  this  class  of  business. 

Other  evidence  might  be  cited,  but  the  above  gives  a  fair 
picture  of  the  situation  as  revealed  by  all  the  testimony  re- 
ceived—  a  confused  picture  of  widely  varying  conditions. 
Public  opinion  is  now  being  aroused  on  the  subject  of  agri- 
cultural credit,  and  pressure  is  liable  to  be  brought  for  hasty 
and  perhaps  radical  legislation.  Obviously,  the  first  step  to 
be  taken  in  the  interest  of  a  sane  solution  of  the  problem  is  to 
find  out  exactly  what  the  problem  is.  To  this  end  the  writer 
would  urge  strongly  the  need  of  investigations  by  the  Comp- 
troller of  the  Currency  and  by  the  various  state  banking  de- 
partments of  the  present  facilities  and  practices  in  the  matter 
of  agricultural  loans.  In  view  of  the  increasing  public  interest 
in  the  subject  the  investigations  cannot  be  undertaken  too 
soon. 

Although  the  farmers  in  any  section  of  the  country  may  not 
resort  to  the  banks  for  short-time  credit  it  does  not  follow 
that  they  are  not  receiving  such  credit.  As  a  matter  of  fact 
they  are  often  receiving  it  on  a  considerable  scale  and  in  the 
most  expensive  way,  i.  e.,  in  the  form  of  book  credits  with 
merchants.  It  is  a  common  practice  throughout  the  country 
for  farmers  to  run  up  book  accounts  with  local  merchants  dur- 
ing the  spring  and  summer  to  be  paid  in  the  fall  when  the  crops 
are  sold.  When  this  is  done  on  any  considerable  scale  the 

1  Cf.  Testimony  before  United  States  Industrial  Commission  (Report, 
X ,  under  subjects  of  "  Credit  System  "  and  "  Crop  Lien  System,"  passim. 


STORE  LIEN  SYSTEM  583 

farmer  probably  pays  more  than  bank  interest  under  the  guisa 
of  prices ;  and  this  is  particularly  true  when  he  obligates  him- 
self to  sell  his  crops  to  the  creditor  merchant.  In  the  South 
this  practice  is  carried  to  the  extreme  in  the  familiar  "  store- 
lien"  system  which  holds  many  farmers  in  the  cotton  belt  in 
a  condition  bordering  on  perpetual  servitude.  The  custom  is 
for  the  farmer  to  buy  supplies  of  the  local  general  store  on 
credit  for  the  year,  agreeing  to  sell  to  the  merchant  his  cotton 
crop  in  the  fall,  thereby  cancelling  the  debt.  A  crop  lien  is 
generally  given,  and  the  merchant  often  dictates  the  character 
and  the  amount  of  the  planting.  The  prices  paid  for  cotton 
under  this  system  are  liable  to  be  exceptionally  low,  and  the 
prices  paid  by  the  farmer  for  his  supplies  exceptionally  high. 
The  system  has  proven  a  curse  to  many  sections  of  the  South. 
Witnesses  before  the  United  States  Industrial  Commission 
estimated  the  interest  rates  imposed  by  this  system  at  from 
20  per  cent,  upwards.  Mr.  George  K.  Holmes  of  the  United 
States  Department  of  Agriculture  testified : 

The  rate  of  interest  on  the  liens  on  the  cotton  crop  of  the  South, 
it  is  safe  to  say,  probably  averages  50  per  cent,  a  year.  All  cotton 
men  will  agree  that  it  is  at  least  that.  The  store  system  of  the 
South  is  a  sort  of  peonage;  that  is  what  it  amounts  to  with  the 
cotton  planter.1 

Since  the  Industrial  Commission's  report  was  published  the 
banking  facilities  of  the  South  have  been  greatly  increased, 
and  the  banks  are  coming  into  closer  touch  with  farmers, 
with  the  result  that  the  store-lien  system  is  gradually  breaking 
down. 

Another  form  of  credit  to  farmers  is  that  obtained  from 
dealers  in  farm  implements  and  machinery  which  the  farmers 
frequently  buy  on  time,  paying  interest  during  the  credit 
period. 

One  informant,  who  has  been  a  bank  examiner,  writes  from 
California  —  and  his  testimony  is  applicable  to  many  other 
sections  of  the  country: 

The  new  generation  of  merchants  is  not  disposed  to  carry,  the 
farmer  as  of  old  and  insists  that  overdue  accounts  be  covered  by 

^  Report.  X,  p.  161. 


584        AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

promissory  notes  which  are  in  turn  hypothecated  with  their  bank. 
In  other  words  a  clearer  demarcation  of  function  is  being  gradually 
brought  about  to  the  best  interests  of  all  concerned. 

Such  in  general  is  the  present  situation  in  the  United  States 
in  the  matter  of  short-time  agricultural  credit  as  evidenced 
by  the  very  indefinite  and  scant  information  available.  What 
are  the  causes?  Perhaps  in  them  will  appear  some  sugges- 
tions for  the  remedy. 

The  chief  reasons  for  the  backwardness  of  the  United  States 
as  compared  with  Europe  with  regard  to  agricultural  credit 
may  be  briefly  summarized  as  follows :  ( I )  Our  wonderful 
agricultural  domain  where  good  land  could  be  had  almost  for 
the  asking,  and  where  for  generations  land  was  so  cheap  and 
labor  and  capital  so  dear  that  intensive  cultivation  was  gen- 
erally unprofitable.  (2)  The  prosperity  of  our  farmers  who 
have  not  been  forced  by  dire  necessity  to  resort  to  credit  as 
were  the  farmers  of  Germany  at  the  middle  of  the  last  century 
when  the  Raiffeisen  co-operative  banks  were  first  organized. 
(3)  The  nomadic  character  of  a  considerable  part  of  our  agri- 
cultural population  as  it  has  moved  continually  westward  in 
taking  up  of  new  lands,  and  more  recently  as  it  has  been  re- 
tracing its  steps  or  moving  northward.  (4)  The  isolation  of 
our  farmers  in  this  country  of  large  farms  and  "  magnificent 
distances."  (5)  The  rapid  growth  of  the  manufacturing  and 
commercial  business  of  the  country  —  and  that  largely  in  the 
hands  of  the  same  class  of  people  who  control  the  bulk  of  the 
banking  business.1 

Add  to  these  circumstances  the  obstacles  which  farmers  al- 
ways encounter  in  the  matter  of  credit,  as  compared  with 
manufacturers  and  merchants,  obstacles  such  as  the  uncer- 
tainty of  crops  and  the  strongly  seasonal  character  of  the 
farmer's  credit  demands,  and  we  have  a  sufficient  explana- 
tion for  the  backwardness  of  agricultural  credit  in  this  coun- 
try. 

To  emphasize  most  of  these  causes,  however,  is  to  brand 
oneself  as  belonging  to  a  past  generation.  Our  domain  of 

1  In  some  states  farmers  themselves  own  considerable  amounts  of  bank 
capital.  This  is  said  to  be  particularly  true  of  Iowa. 


VALUE  OF  FARM  IMPLEMENTS  585 

free  arable  land  is  practically  gone ;  good  farms  must  be  bought, 
and  for  them  ever  increasing  prices  must  be  paid.1 

The  era  of  hand  cultivation  is  giving  way  to  that  of  farm 
machinery  propelled  by  horse-power  and  even  by  steam,  gaso- 
line, or  electricity,  with  its  resulting  great  increase  in  the  effi- 
ciency of  labor.  Eleven  years  ago  the  editor  of  The 
Dakota  Farmer,  in  his  testimony  before  the  United  States  In- 
dustrial Commission,  put  the  matter  tersely,  and  with  little 
exaggeration,  as  affecting  his  own  section  of  the  country,  at 
least,  when  he  said :  "  When  I  first  worked  out  it  took  five 
binders  to  follow  a  machine,  one  man  to  rake  off,  and  one  to 
carry  the  bundles  together.  Now  the  hired  girl  frequently 
drives  a  machine  that  does  the  whole  business."  2  Some  idea 
of  the  extent  of  this  increase  may  be  obtained  by  reference  to 
the  following  figures  compiled  from  census  reports : 

VALUE  OF  FARM  IMPLEMENTS  AND  MACHINERY  IN  THE  U.  S.8 

Year  Value  Per  Cent. 

000,000  Increase 

1910  $1,265  69 

1900  750  52 

1890  494  22 

1880  407  50 

1870  *  271  10 

1860  246  62 

The  increase  in  the  value  of  farm  implements  and  ma- 
chinery per  acre  of  land  in  farms  from  1900  to  1910  was  from 
$0.89  to  $1.44,  or  61.8  per  cent. 

An  analysis  of  the  figures  for  farm  machinery  by  geographic 
divisions  shows  a  marked  difference  in  the  rates  of  increase, 
but  the  tendency  in  all  sections  during  the  last  forty  years  has 
been  decidedly  upwards,  the  greatest  growth  having  been  wit- 
nessed in  the  decade  ending  1910.  During  that  decade  the 
lowest  rate  of  increase  in  any  section  was  that  of  New  Eng- 

1  The  average  value  per  acre  of  farm  land  in  the  United  States  rose  from 
$15.57  in  1900  to  $32.40  in  1910,  a  rise  of  108  per  cent.    Thirteenth  Census, 
Bulletin  on  Farms  and  Farm  Property,  p.  15. 

2  Report,  X,  p.  938. 

s  Exclusive  of  Alaska  and  Hawaii. 
*  Values  in  gold. 


586       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

land,  39  per  cent.,  and  the  highest  that  of  the  Mountain  States, 
163  per  cent.1 

Another  development  which  is  making  larger  demands  upon 
the  farmer  for  working  capital  is  the  increasing  use  of  arti- 
ficial fertilizers,  the  expenditure  for  which  in  the  United  States 
approximately  doubled  from  1880  to  1900. 

As  the  result  of  such  tendencies  and  of  the  rapid  depletion 
of  our  free  domain,  farming  in  the  United  States  is  losing  its 
old-time  kinship  to  mining  and  becoming  more  like  manufac- 
turing. More  and  better  machinery  and  more  power  are 
needed  on  most  farms  in  the  interest  of  efficiency.  This  calls 
for  short-time  credit.  But  a  supply  of  good  machinery  re- 
quires a  fair  sized  farm  for  its  efficient  utilization  —  hence  the 
need  for  larger  farms  and  for  mortgage  credit  to  make  their 
purchase  possible.  Upon  this  subject  there  are  some  very 
illuminating  data  in  Warren  and  Livermore's  Agricultural 
Survey  of  four  townships  in  Tompkins  County,  N.  Y.,  from 
which  the  following  is  quoted : 

The  value  of  farm  machinery  increases  rapidly  with  the  size  of 
the  farm.  .  .  .  Any  one  who  has  ever  made  a  list  of  the  necessary 
farm  machinery  will  see  at  once  how  inadequately  these  small  farms 
are  equipped.  Yet  their  machinery  costs  nearly  twice  as  much  per 
acre  as  that  on  the  larger  farms  that  have  nearly  three  times  as 
much  machinery.  Machinery  can  be  used  more  effectively  on  large 
farms.  One  mower,  one  hay  rake,  one  tedder,  one  hay  loader,  one 
corn  harvester,  one  grain  harvester,  one  grain  drill,  one  manure 
spreader,  one  potato  digger,  one  potato  planter,  can  do  their  work 
on  a  250  acre  farm  as  readily  as  on  a  small  farm.  Few  of  the  small 
farms  have  half  of  these  tools.  If  a  small  farm  does  have  nearly 
all  the  list,  it  cannot  use  them  enough  to  pay  for  the  investment. 
The  more  efficient  and  numerous  machines  become,  the  larger  our 
farms  should  be.  It  is  interesting  to  notice  how  many  of  the  tools 
are  of  very  recent  development.  Almost  half  of  the  value  of  farm 
machinery  on  a  well-equipped  farm  is  invested  in  machinery  that 
has  been  perfected  in  the  last  few  years. 

Much  the  same  situation  exists  in  regard  to  an  adequate 
equipment  of  horses. 

Three  or  four  horses  are  the  smallest  number  that  can  be  used 
efficiently  with  modern  machinery.  .  .  .  The  small  farms  have  not 

1  Cf.  Twelfth  Census,  V,  pp.  xxixand  xxx,  and  Thirteenth  Census,  Bulle- 
tin on  I'-arm  and  l:arm  Property  by  States,  pp.  13  and  15. 


NEED  OF  LONG  TIME  CREDIT  587 

enough  horses  to  make  efficient  teams  and  yet  they  are  over-supplied 
with  horses  compared  with  their  area.  On  these  farms  there  are 
only  15  acres  per  horse.  On  the  largest  farms,  one  horse  farms 
three  times  this  area,  with  no  resulting  decrease  in  crop  yields.  .  .  . 
When  we  consider  the  cost  of  keeping  a  horse  we  see  what  a  great 
advantage  the  larger  farms  have. 

Forces  like  these  are  counteracting  what  is  commonly 
thought  of  as  the  normal  tendency  of  agriculture  to  move 
toward  more  intensive  cultivation  on  small  farms,  with  the 
result  that  the  average  amount  of  improved  farm  land  per 
farm  actually  increased  instead  of  diminishing  in  the  United 
States  during  the  last  decade.  This  does  not  mean  less  in- 
tensive cultivation,  in  fact  quite  the  contrary;  it  means  more 
intensive  cultivation,  but  by  the  efficient  utilization  of  good 
machinery  and  of  power.  It  means  further,  as  said  above, 
a  demand  for  mortgage  credit  for  the  purpose  of  enlarging 
farms  —  and  that,  at  rapidly  increasing  farm  prices. 

The  farming  population  is  becoming  more  settled  now  that 
the  free  lands  are  practically  gone  and  the  frontier  has  dis- 
appeared.1 The  isolation  of  the  farmer  is  rapidly  becoming 
a  thing  of  the  past,  with  the  advent  of  rural  free  delivery, 
rural  telephone,  the  automobile,  and  the  parcels  post.  The 
farmer  no  longer  buys  gold-bricks  nor  is  duped  by  fraudulent 
lightning-rod  schemes  except  in  the  pages  of  the  comic  sup- 
plements. 

When  seeking  credit  the  farmer  can  offer  better  security 
than  ever  before.  His  markets  are  larger,  better  organized, 
more  certain,  and  more  accessible.  The  risk  of  crop  failure 
is  less,  thanks  to  the  wonderful  progress  of  scientific  agri- 
culture. There  are  few  pests  which  cannot  now  be  readily 
controlled  by  the  intelligent  farmer,  who  takes  time  by  the 
forelock.  The  problem  of  moisture  is  growing  less  serious 
every  year  with  the  improvements  in  irrigation,  dry  farming, 
and  the  more  scientific  diversification  of  crops. 

Conditions  then  point  to  an  increasing  need  for  agricultural 
credit,  and  to  improving  circumstances  for  its  safe  develop- 
ment. 

If  the  time  is  ripe  for  a  greater  use  of  bank  credit  in  agri- 

1  Every  census  since  1870  lias  shown  a  larger  percentage  of  the  native 
population  living  in  state  or  territory  of  birth. 


588       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

culture,  how  is  that  credit  to  be  obtained  ?  Broadly  speaking, 
four  methods  may  be  mentioned,  only  the  last  two  of  which 
are  deserving  of  much  attention  at  the  present  time.  They 
are:  (i)  Establish  government  agricultural  banks;  (2) 
adopt  the  Egyptian  plan  of  a  government  guaranty  to  an  agri- 
cultural bank  established  with  private  capital;  (3)  encourage 
the  farmers  to  organize  co-operative  credit  societies  on  some 
such  plan  as  the  Raiffeisen  or  Schulze-Delitzsch  banks  of  Ger- 
many; (4)  utilize  more  effectively  in  the  interest  of  the 
farmer  our  present  banking  machinery,  and  improve  it  where 
it  is  defective. 

The  suggestion  of  an  agricultural  bank  owned  and  operated 
by  government,  either  state  or  federal,  is  not  worthy  of  serious 
consideration  in  this  country  at  the  present  time.  The  history 
of  such  banks  both  in  Europe  and  America  has  generally  been 
a  disastrous  one,  although  a  few  have  succeeded.  Some  exist 
to-day  which  are  performing  useful  sen- ices  to  farmers,  nota- 
bly in  the  line  of  mortgage  credit,  among  which  may  be  men- 
tioned those  of  the  Australian  States  and  New  Zealand,1  and 
the  recently  established  one  in  the  Philippine  Islands.  The 
success  of  such  institutions  is  not  such  as  to  justify  any  attempt 
to  establish  them  in  the  United  States,  at  least  until  every  rea- 
sonable effort  has  been  made  to  solve  the  problem  by  means  of 
private  and  co-operative  effort. 

The  other  plan,  commonly  known  as  the  Egyptian  plan  2 
from  its  most  important  example,  seeks  to  eliminate  the  evils 
of  a  purely  government  bank  and  to  take  advantage  of  its. 
meritorious  features.  In  Egypt  the  agricultural  bank  is  owned 
and  financed  by  private  capital;  it  enjoys,  however  a  govern- 
ment guaranty  of  principal  and  of  3  per  cent,  interest.  Its  ad- 
ministrative expenses  are  kept  low  by  an  arrangement  with  the 
Egyptian  Government  by  which  the  Government  tax  collectors 
make  collection  of  instalments  on  the  Bank's  loans  at  the  time 

1  On  this  subject  see  the  writer's  article  on  "  Agricultural  Credit "  in 
L.  H.  Bailey's  Cyclopedia  of  American  Agriculture,  IV,  p.  270;  and  his 
Report  to  the  Treasurer  of  the  Philippine  Islands  on  The  Advisability  of 
Establishing  a  Government  Agricultural  Bank  in  the  Philippine  Islands, 
pp.  9-n,  151-154. 

2  Cf .  E.  W.  Kemmerer,  Report  to  the  Secretary  of  War  and  to  the  Philip- 
pine Commission,  on  The  Agricultural  Bank  of  Egypt.     (Manila.  P.  I.: 
1906.    Also  published  by  Bureau  of  Insular  Affairs,  Washington,  D.  C.) 


CO-OPERATIVE  BANKS  OF  GERMANY  589 

of  the  collection  of  the  regular  land  tax,  for  which  the  Bank 
pays  a  small  commission.  The  Agricultural  Bank  of  Egypt 
has  had  a  phenomenal  success,  rendering  an  invaluable  service 
to  the  Egyptian  fellaheen,  and  at  the  same  time  yielding  good 
profits  to  its  owners.  It  was  this  type  of  bank  that  the  United 
States  Government  authorized  established  in  the  Philippines 
by  the  act  of  March  4,  1907,  but  the  interest  guaranty  of  4  per 
cent,  has  so  far  proved  too  low  to  attract  capital  into  the  enter- 
prise.1 

A  bank  organized  on  the  Egyptian  plan  is  well  adapted  to 
do  pioneer  work  among  ignorant  farmers,  where  the  apparent 
risks  and  heavy  administrative  expenses  prevent  private  capital 
from  entering  the  field.  A  government  guaranty,  however, 
hardly  seems  necessary  in  the  United  States,  and  our  people 
would  probably  look  askance  at  any  proposal  for  a  great  agri- 
cultural bank  or  banks  of  this  type  with  branches  scattered 
throughout  the  country.  It  is  contrary  to  our  banking  tradi- 
tions, and,  like  the  plan  for  a  strictly  government  bank,  should 
not  be  thought  of  until  plans  for  meeting  the  need  by  private 
initiative  have  been  fairly  tried  and  found  wanting. 

When  one  considers  the  question  of  the  improvement  of 
agricultural  credit  in  the  United  States  one  instinctively  thinks 
of  the  co-operative  credit  banks  of  the  old  world,  because  of 
their  phenomenal  success  for  a  half  century  and  more,  the 
simplicity  of  their  structures,  the  ease  with  which  they  may  be 
established,  and  their  ready  adaptability  to  the  widely  varying 
conditions  found  in  a  great  country  like  the  United  States. 
The  description  of  the  wonderful  success  of  these  institutions 
as  told  by  Henry  W.  Wolff  in  his  People's  Banks  reads  like  a 
fairy  story.  Although  the  success  of  co-operative  banks  has 
been  great  in  nearly  every  country  of  Continental  Europe,  no- 
where else  has  it  been  so  great  as  in  Germany,  the  country  of 
their  origin,  and  it  is  to  Germany  one  naturally  turns  first  for 
suggestions.  There  we  find  four  types  of  co-operative  credit 
banks,  Landschaften,  Ritterschaften,  Schulze-Delitzsch  banks 
and  Raiffeisen  banks.  The  first  two  are  co-operative  associa- 
tions loaning  money  on  land  mortgages,  and  securing  funds 

1  Cf.  E.  W.  Kemmerer,  An  Agricultural  Bank  for  the  Philippines.  Yale 
Review,  November,  1907,  pp.  262-279. 


590       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

largely  through  the  issue  of  bonds  against  the  collective  mort- 
gages. Being  concerned  with  long-time  mortgage  credit  they 
do  not  fall  within  the  province  of  this  paper.  The  other  two 
types  of  banks  deal  especially  with  short-time  credit,  the  one 
chiefly  in  the  towns  and  cities,  and  the  other  with  farmers  in 
the  rural  communities.  It  is  with  the  latter  that  we  are  most 
concerned.  Let  us  therefore  consider  briefly  the  essential  fea- 
tures of  the  Raiffeisen  system. 

These  features  are:  (i)  Organization  on  the  strictly  co- 
operative principle,  none  but  members  having  the  right  to  bor- 
row, although  non-members  may  make  deposits.  (2)  Limita- 
tion of  loan  operations  to  a  very  small  area  in  which  all  farmers 
are  acquainted  with  each  other.  A  bank's  field  of  business, 
the  founder  believed,  should  not  cover  a  parish  of  less  than 
400  people  nor  of  more  than  1,500.  The  banks,  were  to  be, 
therefore,  purely  neighborhood  affairs.  There  is  a  sympa- 
thetic but  well-informed  neighborhood  opinion  which  pre- 
vents the  squandering  of  loans.  (3)  Unlimited  liability  of  all 
members  for  the  debts  of  the  bank,  a  necessary  corollary  of 
which  is  the  provision  that  membership  is  obtained  only  by 
election  by  those  already  members.  (4)  The  working  capital 
of  the  bank  is  obtained  chiefly  from  the  following  sources: 
(a)  Small  savings  "  drawn,  either  from  within  the  area  cov- 
ered by  the  bank,  in  which  case  it  comes  both  from  members 
and  non-members,  the  former  being  rewarded  where  possible 
at  slightly  higher  rates  in  order  to  encourage  membership ;  or 
from  without  the  area,  in  which  case  it  of  necessity  comes  from 
non-members."  x  (b)  Loans  from  the  provincial  bank  of  the 
district,  or  more  importantly  from  the  central  bank  of  the 
Empire  at  which  the  local  bank  keeps  a  current  account  and 
with  which  it  may  rediscount  its  paper.  Funds  are  also  some- 
times obtained  from  other  banks  or  from  private  individuals, 
(c)  A  purely  nominal  share  capital  which  the  banks  did  not 
originally  have,  and  which  they  have  been  forced  against  their 
will  to  issue.  The  requirement  is  now  usually  met  by  the  issue 
of  a  few  low-priced  shares  of  which  no  member  can  hold  more 
than  one  and  upon  which  no  dividend  is  paid,  (d)  Two  sur- 

iC.  R.  Fay,  Co-operation  at  Home  and  Abroad,  p.  44-    (New  York; 
Macmillan,  1908.) 


CO-OPERATIVE  BANKS  OF  GERMANY  591'- 

plus  funds  called  reserve  funds;  one  used  exclusively  to  cover 
losses,  and  the  other  being  the  principal  reserve  fund  (Stift- 
ungsfund),  commonly  used  for  "positive  improvements,  such 
as  the  extension  of  the  premises  or  the  establishment  of  a 
burial  fund."  *  In  this  fund  must  be  placed  two-thirds  of  the 
annual  profits.  The  fund  cannot  be  distributed  among  the 
members,  even  though  the  bank  be  dissolved.  In  such  a  case 
it  is  held  in  trust  for  a  time  for  a  new  bank,  should  one  be 
established,  and  if  no  such  bank  is  established  it  must  be  used 
for  some  work  of  public  utility.  A  recent  publication  of  the 
International  Institute  of  Agriculture 2  analyses  the  total 
working  capital  of  the  rural  banks  of  Germany  for  the  year 
1909  as  follows: 

Amount  Percentage 
in  Marks 
000,000 

Share  capital   224  1.2 

Reserves  51.0  2.6 

Deposits  on  current  account  189.1  9.8 

Savings    deposits    1,455-6  75.2 

Other  liabilities 3  217.5  1 1.2 

Total  working  capital  1,935-5  100.0 

The  striking  fact  brought  out  by  these  figures  is  that  out  of 
nearly  two  billion  marks  placed  at  the  disposal  of  farmers,  less 
than4  11.2  per  cent,  was  furnished  by  outsiders,  while  more 
than  88.8  per  cent,  was  provided  by  the  savings  and  other  de- 
posits of  the  farmers  themselves  and  of  the  local  public.  (5) 
A  fifth  feature  of  the  Raiffeisen  system  is  that  the  bank's  ad- 
ministrative organization  is  simple  and  democratic.  Final 
authority  on  local  questions  resides  in  the  general  meeting  in 
which  every  member  has  one  vote.  There  is  elected  annually 
a  committee  of  management  consisting  usually  of  five  or  six 
directors  who  meet  weekly.  As  a  check  upon  this  executive 
committee  there  is  also  elected  annually  a  council  of  supervi- 
sion consisting  of  from  six  to  nine  members.  A  biennial  audit 

1  Fay,  Co-operation,  etc.,  p.  44. 

2  An  Outline  of  the  European  Co-operative  Credit  Systems,  pp.  12  and 

13- 

3  Under  "other  liabilities"  are  included  in  addition  to  other  items  the 
funds  which  the  banks  have  borrowed  from  banks  and  individual  capital- 
ists. 

4  The  capital  of  the  district  banks  and  of  the  central  bank  came  largely 
from  the  local  banks. 


592       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

is  made  of  the  accounts  of  each  bank  by  an  accountant  em- 
ployed by  the  district  or  central  union.  The  books  of  the  bank, 
except  the  individual  deposit  ledger,  are  open  to  the  inspection 
of  all  members.  Officers  of  the  local  banks  serve  without  com- 
pensation, except  the  treasurer  who  has  no  vote  in  the  making 
of  loans.  .  .  .  (6)  Advances  take  two  forms:  the  ordinary 
loan  (of  which  the  name  is  sufficiently  descriptive),  and  the 
current  account  which  is  similar  to  the  Scotch  cash  credit. 
The  latter  constitute  about  a  third  1  of  the  total  and  show  a 
tendency  to  increase  in  proportion  to  the  ordinary  loans.  The 
period  of  the  ordinary  loan  varies  from  six  months  to  three 
years ;  and  in  exceptional  cases  it  may  be  even  longer.2  Loans 
are  repayable  in  instalments  covering  interest  and  part  of  the 
principal,  or  in  lump  sums.  Banks  reserve  the  right  to  call  a 
loan  on  four  weeks'  notice.  The  average  credit  -advanced  per 
member  is  500  marks,  and  the  average  interest  rate  probably 
somewhere  between  4  and  5  per  cent.  Although  mortgage  and 
other  collateral  security  is  sometimes  accepted,  the  banks'  chief 
reliance  is  personal  security,  and  the  great  bulk  of  the  loans 
are  made  on  two-name  paper. 

The  Raiffeisen  banks  are  organized  into  provincial  federa- 
tions with  provincial  banks  at  their  head,  and  these  in  turn 
into  a  national  federation  with  a  central  bank  at  its  head. 
These  provincial  banks  and  the  central  bank  "  equalize  the  need 
of  credit  of  the  individual  banks,  supplying  them  with  money 
when  required  and  employing  their  surplus  funds."  3  A  large 
proportion  of  the  German  co-operative  banks  and  other  co- 
operative agricultural  societies  are  federated  in  a  single  na- 
tional organization,  the  National  Federation  of  Darmstadt.4 

Such  are  the  leading  features  of  the  greatest  agricultural 
credit  system  of  the  world.  To  the  American  the  surprising 
thing  about  it  all  is  that  such  co-operative  credit  banks  are 
practically  unknown  in  the  United  States,  although  there  has 
been  a  remarkable  development  here  in  recent  years  of  other 

1  In  1909  the  figures  for  Germany  were :  Loans  on  current  account,  M 
425,995,403  and  Loans  for  fixed  periods,  M  1,082446,388.    The  International 
Institute  of  Agriculture,  An  Outline,  etc.,  p.  14. 

2  Idem. 

3  Ibid.,  p.  17. 

4  Idem. 


WHAT  IS  NEEDED  593  - 

forms  of  co-operation  among  farmers.1  This  surprise  is  the 
greater  when  one  bears  in  mind  that  "  whole  counties  have 
been  populated  in  the  Northwest  by  European  agriculturists 
who  came  from  neighborhoods  where  they  were  familiar  with 
agricultural  co-operative  credit,  and  yet  not  a  society  of  co- 
operative credit  for  these  immigrants  has  been  established  from 
the  beginning  to  the  present  time."  .  .  ,2 

What  is  needed  now  —  and  possibly  about  all  that  will  be 
needed  in  the  future  —  is  a  campaign  of  education  among  the 
farmers  themselves  rather  than  one  of  legislation;  although 
the  development  of  such  societies  will  doubtless  be  furthered 
in  many  states  by  legislation,  such  as  was  recently  enacted  in 
Massachusetts  (ch.  419,  Acts  of  1909),  freeing  them  from 
some  of  the  hampering  provisions  of  the  general  banking  act 
of  the  state.  Conditions  are  so  widely  different  in  different 
sections  of  the  country,  and  among  different  classes  in  the 
same  section,  that  co-operative  agricultural  credit  societies  will 
need  to  be  given  a  fairly  free  hand  in  such  matters  as  limited 
or  unlimited  liability,  the  amount  of  share  capital,  receipt  of 
deposits,  etc.,  so  that  they  may  adapt  themselves  to  local  needs. 
A  reasonable  amount  of  government  supervision  on  the  part 
of  the  banking  departments  of  the  states  seems  desirable. 

Passing  now  to  the  question  of  the  better  utilization  of  our 
existing  banking  machinery,  we  may  consider  it  first  from  the 
standpoint  of  the  Government,  then  from  that  of  the  banks, 
and  finally  from  that  of  the  farmers  themselves. 

The  provisions  of  the  national  banking  act  (Revised  Stat- 
utes,  Sec.  5137)  are  too  rigid  in  the  matter  of  loans  on  real 
estate  security.3  National  banks  are,  of  course,  intended  to 

1 "  Farmers'  economic  co-operation  in  the  United  States  has  developed 
enormously  during  the  period  under  review  [1896-1908],  and  it  safe  to  say 
that  at  the  present  time  more  than  half  of  the  6,100,000  farms  are  repre- 
sented in  economic  co-operation;  the  fraction  is  much  larger  if  it^  is 
based  on  the  total  number  of  medium  and  better  sorts  of  farmers  to  which 
the  cooperators  mostly  belong."  The  most  prominent  objects  are:  In- 
surance, creameries,  cheese  factories,  co-operative  selling  organizations  of 
numerous  kinds,  co-operative  buying  organizations,  co-operative  ware- 
houses, co-operative  telephones,  co-operative  irrigation,  etc.  Annual  Re- 
port of  the  Secretary  of  Agriculture  1908,  pp.  183,  184. 

2  Quoted  from  a  letter  from  Mr.  George  K.  Holmes,  Statistician  of  the 
Department  of  Agriculture,  Washington,  D.  C. 

3  For  a  statement  of  the  more  liberal  privileges  concerning  the  making 


'594        AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

be  banks  for  business  men,  and  their  assets  should  be  quick 
assets  in  so  far  as  their  liabilities  are  quick  liabilities.  But  it 
should  not  be  overlooked  that  the  modern  farmer  is  a  business 
man,  that  he  needs  active  credit  for  the  efficient  conduct  of  his 
current  business,  and  that  land  is  the  only  kind  of  collateral 
many  farmers  can  give  that  is  acceptable  to  bankers.  Many 
worthy  farmers  are  not  willing  and  some  are  not  able  to  secure 
satisfactory  endorsers  to  their  paper.  Crop  liens,  except  in 
the  South,  are  not  usually  very  acceptable  to  banks.  The  abil- 
ity of  the  farmer  to  give  mortgage  security  to  national  banks 
in  case  of  need  would  often  prove  a  great  help.  Furthermore, 
now  that  a  majority  of  our  national  banks  have  savings  depart-1 
ments,  and  that  savings  deposits  might  wisely  be  made  with- 
drawable subject  to  advance  notice,  it  is  not  unreasonable  that 
these  banks  should  be  permitted  to  invest  at  least  a  substantial 
part  of  their  savings  funds  in  the  same  kinds  of  mortgage 
securities  that  are  open  to  the  investment  of  funds  of  savings 
banks ;  provided,  of  course,  that  due  care  be  taken  to  prevent 
the  juggling  of  accounts  between  the  commercial  department 
and  the  savings  department  of  the  bank. 

Another  form  of  desirable  legislation  in  the  interest  of  the 
farmer  consists  in  the  abandonment  of  our  unscientific  bond 
secured  bank-note  circulation  for  a  scientific  system,  and  in 
the  rendering  of  our  deposit  currency  more  elastic.  The  more 
the  farmer  resorts  to  bank  credit  as  a  means  of  financing  his 
current  business  the  more  will  he  suffer  from  the  seasonal  in- 
elasticity of  our  bank-note  and  deposit  currency.  Farming 
business  is  pre-eminently  seasonal  in  character;  the  farmers 
over  the  greater  part  of  the  country  need  funds  most  at  about 
the  same  times  of  the  year,  i.  e.,  the  fall  and  spring.  A  great 
increase  in  the  demand  for  currency  and  capital,  say  in  the 
fall,  under  an  inelastic  currency  and  credit  system  like  our 
own,  means  to  the  farmer,  highest  interest  rates  at  just  the 
time  when  he  needs  most  to  borrow,  greatest  scarcity  of  cash 
at  just  the  time  when  his  need  for  cash  is  the  most  urgent,  and 
prices  depressed  by  a  tight  money  market  at  the  time  of  the 
year  when  he  has  most  to  sell.  It  is  doubtful  if  any  class  of 

of  loans  on  mortgage  security  conferred  on  national  banks  by  the  Federal 
Reserve  Act  see  p.  750. —  EDITOR. 


WHAT  IS  NEEDED  595 

people  in  the  country  would  benefit  more  from  a  thorough- 
going reform  of  our  banking  system  than  would  the  farmers. 

The  apportionment  of  responsibility  between  farmer  and 
banker  for  their  not  having  gotten  together  better  is  an  im- 
possible task.  Although  some  exceptions  must  be  made,  par- 
ticularly in  the  Middle  West,  as  a  general  proposition  neither 
has  appreciated  the  opportunity  which  the  other  offered. 

The  banker  must  be  brought  to  realize  that  one  of  the  best 
kinds  of  paper  in  the  world  is  short-time  business  paper  bear- 
ing the  names  of  two  responsible  farmers.  He  should  be  an 
adviser  and  friend  to  the  farmer  as  much  as  to  the  city  cus- 
tomer. He  should  make  the  farmer  feel  that  a  productive 
loan  to  him  is  not  of  the  nature  of  a  favor  reluctantly  granted 
—  as  so  many  farmers  complain  —  but  rather  a  business  prop- 
osition profitable  to  both,  as  gladly  given  as  it  is  received.  He 
should  further  co-operate  with  the  local  business  men  in  pre- 
paring financial  ratings  of  farmers,  to  fill  the  gap  left  by  the 
inability,  to  be  hoped  temporary,  of  mercantile  credit  agencies 
to  rate  farmers  as  extensively  as  they  do  other  business  men 
of  like  capital. 

The  farmer,  on  the  other  hand,  must  be  educated  by  the 
banker,  the  press,  and  the  agricultural  school  and  college,  to 
the  advantages  of  credit  as  a  mean  to  the  more  efficient  work- 
ing of  his  farm.  This  should  be  done  with  caution,  for  credit 
is  a  two-edged  sword.  The  farmer  should  be  encouraged  to 
borrow  only  when  it  is  very  clear  that  he  can  use  additional 
capital  so  productively  that  it  will  pay.  But  what  industrious 
farmer  could  not  use  profitably  some  additional  capital  every 
year,  could  he  obtain  it  at  as  reasonable  rates  as  does  the  mer- 
chant? The  farmer  must  learn  to  keep  careful  accounts.  He 
must  be  made  to  realize  that  the  banks  are  open  to  him  as  to 
other  business  men,  and  that  the  bulk  of  the  country's  short- 
time  commercial  loans,  as  likewise  of  the  agricultural  loans  of 
Europe,  are  made  on  the  very  same  security  he  is  capable  of 
giving,  i.  e.,  two-name  paper  of  honest,  industrious  business 
men. 


596       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 


FARM  CREDIT  IN  A  NORTHWESTERN  STATE  J 

LONG-TIME   LOANS 

In  North  Dakota  the  average  farm  mortgage  runs  for  4.94 
years;  and  the  average  interest  rate  is  approximately  8  per 
cent,  (accurately  7.88  per  cent.).  This  8  per  cent,  does  not 
include  the  expense  of  abstracting  titles,  examining  the  prop- 
erty, and  the  recording  of  the  mortgage.  These  fees  are  in- 
variably paid  by  the  borrower.  Nor  does  this  interest  rate 
of  8  per  cent,  take  account  of  the  bonus  that  is  frequently 
exacted,  in  the  newer  regions,  from  the  borrower  for  the 
privilege  of  securing  a  loan;  nor  does  it  allow  for  the  sum 
the  borrower  loses  in  paying  his  yearly  interest  in  advance, 
which  is  deducted  from  the  principal.  While  the  practice  of 
exacting  a  bonus  is  not  common,  it  is  generally  the  custom 
to  deduct  the  entire  year's  interest  in  advance;  assuming  an 
8  per  cent,  rate,  the  farmer  therefore  pays  $80  interest  not  on 
$  1,000  but  on  $920,  which  brings  the  rate  up  to  8.7  per  cent. 

While  the  average  prevailing  rate,  according  to  our  returns, 
is  approximately  8  per  cent,  the  rate  varies  in  different  parts 
of  the  state,  depending  upon  the  local  conditions.  The  rates 
are  lowest  in  the  eastern  tier  of  counties,  and  rise  gradually 
towards  the  western  part  of  the  state,  where  the  rate  runs 
up  to  10  and  12  per  cent.,  which  is  also  the  rate  in  the  eastern 
part  of  Montana.  That  the  8  per  cent,  rate  is  quite  general 
for  a  large  part  of  the  state  is  evidenced  from  the  fact  that 
25  of  the  45  counties  report  an  average  rate  of  8  per  cent, 
or  more.  In  only  4  counties  is  the  rate  less  than  7  per  cent., 
and  in  no  county  does  the  average  fall  below  6  per  cent. 

The  above  figures  are  conservative.  They  are  based  on 
returns  submitted  by  bankers  who  would  naturally  under- 
state rather  than  overstate  the  rate  of  interest  charged  in  their 
respective  localities.  Furthermore,  we  have  a  check  on  these 
bank  returns  in  the  replies  received  from  farmers.  As  a  rule 
the  rates  reported  by  bankers  and  farmers  are  nearly  iden- 
tical in  their  respective  counties.  It  is  safe  to  conclude,  there- 

1  Adapted  from  Meyer  Jacobstein,  Farm  Credit  in  a  Northwestern  State, 
American  Economic  Review,  Vol.  3,  September,  1913,  pp.  598-605. 


NORTH  DAKOTA  597 

fore,  that  the  average  rate  on  farm  mortgages  for  the  entire 
state  is  about  8  per  cent. 

SHORT-TIME    LOANS 

Short-time  loans  are  of  two  kinds,  bank  loans  and  book 
credit  advanced  by  retail  stores.  The  bank  loan  is  made  on 
the  farmer's  note,  generally  unsecured,  though  often  secured 
by  a  chattel  mortgage.  According  to  the  reports  received 
from  125  banks,  the  average  length  of  time  for  these  short- 
time  loans  is  8>y2  months ;  and  the  average  rate  of  interest  is 
10.75  Per  cent-  The  average  rate  reported  by  farmers  re- 
siding in  22  different  counties  was  11.07  Per  cent. 

An  effort  was  made  to  compare  rates  paid  by  farmers  with 
those  paid  by  business  men  on  short-time  loans  in  the  same 
locality.  The  same  banks  that  reported  an  average  of  10.75 
per  cent,  to  farmers  averaged  only  9.18  per  cent,  on  loans 
made  to  merchants  and  manufacturers.  Fully  95  out  of  the 
125  reporting  banks  stated  that  the  rate  was  higher  for  agri- 
cultural short-time  loans  than  for  commercial  loans;  26  re- 
ported the  rate  to  be  the  same  for  both  classes;  and  only  4 
reported  a  lower  rate  for  the  farmer.  As  North  Dakota, 
however,  is  not  a  manufacturing  nor  a  jobbing  state,  com- 
mercial paper  is  scarce,  and  consequently  comparisons  of  the 
above  nature  are  apt  to  be  misleading.  The  significant  fact 
remains  that  the  farmer  pays  from  10  to  1 1  per  cent,  on  small 
loans,  for  short  periods  of  time. 

Store  or  book  credit  is  a  form  of  short-time  loan  which  is 
perhaps  more  important  than  bank  credit.  In  a  state  where 
the  bank  charges  a  high  rate  of  interest,  the  farmer  is  more 
likely  to  buy  merchandise  on  credit  than  to  borrow  from  the 
bank  and  pay  cash.  The  North  Dakota  farmer  is  rarely  de- 
nied credit  at  a  country  store.  To  secure  information  on  this 
form  of  credit,  questionnaires  were  mailed  to  implement  and 
hardware  dealers,  as  well  as  to  farmers.  One*  question  asked 
of  implement  dealers  was:  "What  percentage  of  farmers 
pay  cash  in  buying  farm  machinery?  "  The  answer  from  54 
firms,  located  in  35  counties,  was  that  only  13  per  cent,  of  the 
farmers  pay  cash,  87  per  cent,  buying  on  time.  Out  of  29 
farmers  reporting  only  6  pay  cash  in  buying  machinery  and 


598       AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

supplies.  These  book  accounts  run  anywhere  from  three 
months  to  two  years ;  the  average  account  is  carried  about  one 
year  (12.37  months).  The  farmer  contemplates  making  pay- 
ment immediately  after  his  prospective  crop  is  marketed.  In 
case  of  crop  failure  the  retailer  will  carry  the  account  over 
until  the  next  harvest  season. 

It  is  quite  common  for  the  dealer  to  obtain  a  note  from  the 
farmer  —  the  note  generally  bearing  a  10  per  cent,  interest 
rate  from  the  date  of  issue.  Often,  however,  the  note  does 
not  begin  to  bear  interest  until  the  farmer  has  failed  to  make 
payment  at  the  expected  time,  that  is,  immediately  following 
the  harvesting  season.  The  54  implement  and  hardware 
dealers  reported  an  average  of  10.26  per  cent,  interest  per 
year  on  these  notes. 

It  is  more  difficult  to  secure  uniform  information  from 
dealers  on  the  subject  of  book  credits,  especially  with  reference 
to  the  interest  rates  charged  on  such  accounts.  The  practice 
varies.  Usually  an  interest  rate  is  added  to  the  credit  price 
depending  on  the  duration  of  the  account.  There  is  no  com- 
mon discount  rate  for  cash  purchases,  though  7  per  cent,  is 
most  common,  that  is,  7  per  cent,  of  the  credit  price.  This 
brings  the  credit  price  of  a  $160  binder  down  to  $150  for 
cash.  As  a  matter  of  fact  all  dealers  quote  two  prices,  the 
cash  and  the  credit  price,  the  difference  between  the  two  de- 
pending upon  the  reputation  of  the  buyer,  the  shrewdness  of 
the  seller,  and  the  degree  of  competition  in  the  particular 
locality. 

On  this  point,  replies  from  farmers  do  not  differ  materially 
from  the  replies  of  the  implement  dealers.  The  difference 
between  the  cash  price  and  the  credit  price  of  a  binder  is 
usually  given  as  $5  to  $10,  and  a  wagon  or  plough,  as  $3  to 
$5.  The  general  discount  rate  is  7  per  cent,  off  the  credit 
price. 

The  implement  dealers  and  the  farmers  are  all  agreed  that 
cash  payments  would  be  preferable  if  rates  on  bank  loans 
were  reduced.  The  farmer,  however,  is  often  afraid  to  ap- 
proach the  banker  for  a  loan.  On  the  other  hand,  the  farmer 
does  not  always  see  that  the  book  credit  is  quite  as  expensive 
as  bank  credit,  if  not  more  so.  The  prevailing  high  bank 


NORTH  DAKOTA  '599 

rate,  however,  from  10  per  cent,  to  12  per  cent,  on  short-time 
loans,  does  not  encourage  cash  payments. 

Are  the  foregoing  rates  too  high  as  compared  with  rates 
in  other  communities?  The  Crop  Reporter  for  April, 
1913,  shows  interest  rates  on  short-time  loans  in  every  state 
in  the  Union.  In  1913,  the  North  Dakota  rate  exceeded  that 
of  all  other  States;  in  1912,  it  exceeded  all  but  Oklahoma. 

Farmers  as  a  rule  think  that  rates  are  fixed  arbitrarily  by 
the  bankers  and  other  money  lenders  in  the  community. 
That  fundamental  laws  of  supply  and  demand  have  any  con- 
trolling influence  is  apt  to  be  overlooked.  Without  attempting 
to  justify  the  high  rates  let  us  state  some  of  the  conditions 
which  help  to  explain  them.  The  demand  for  capital  in  a 
growing  state  is  always  greater  than  can  be  met  by  the  local 
supply.  In  1890,  North  Dakota  farms  were  mortgaged  for 
$11,168,854;  in  1910,  for  $47,841,587;  in  1920  it  will  doubt- 
less reach  $150,000,000.  Outside  capital  is  attracted  into  the 
state  by  high  rates  of  interest.  Two  life  insurance  companies, 
the  Union  Central  of  Cincinnati  and  the  Northwestern  Mutual 
of  Milwaukee,  loan  heavily  in  the  state.  In  1910  the  Union 
Central  Life  Insurance  Company  reported  a  total  investment 
of  $5,489,087.33  in  North  Dakota  real  estate.  Local  banks 
use  farm  mortgages  in  borrowing  money  from  banks  in  large 
cities  outside  of  the  state.  Every  town  and  village  has  its 
money-lender  who  acts  as  agent  for  foreign  investors  in  farm 
mortgages.  Banks  within  the  state  compete  for  capital  by 
offering  high  rates  of  interest  on  time  deposits,  and  pay  all  the 
way  from  4^2  to  7  per  cent,  interest  on  deposits.  The  rate 
on  loans  must  necessarily  be  higher  under  these  circumstances 
than  where  banks  are  paying  2^/2  and  3  per  cent  interest. 
The  hi^h  interest  rate  paid  on  bank  deposits  is  evidence  of 
the  lack  of  local  capital  to  satisfy  the  local  demand. 

The  inability  to  attract  foreign  capital  on  lower  terms  is 
due  primarily  to  the  character  of  the  investment.  The  new- 
ness of  the  state,  the  instability  of  its  population,  the  char- 
acter of  its  agriculture,  all  make  for  uncertainty.  Hence  the 
speculative  character  of  the  farm  mortgage  as  security  for  a 
loan.  In  the  eastern  counties  where  the  land  has  long  been 
under  cultivation,  where  the  population  is  more  stable,  and 


fxDO        AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

where  mixed  farming  has  in  a  large  measure  supplanted  the 
bonanza  wheat  farm,  rates  are  correspondingly  lower  than  in 
the  newer  portions  of  the  state.  As  the  element  of  risk  is 
eliminated  from  investments,  interest  rates  will  come  down. 
At  least  this  seems  to  be  the  consensus  of  opinion  among 
bankers. 

The  character  of  the  farming  is  frequently  mentioned  as  a 
prominent  factor  in  the  credit  situation.  A  crop  failure  un- 
der a  single  crop  system,  such  as  is  practised  in  North  Dakota, 
is  likely  to  find  the  farmer  in  bad  straits.  The  payment  of 
interest  on  the  mortgage  is  delayed  or  deferred.  The  local 
bank  or  loan  company  is  obliged  either  to  carry  the  farmer 
along  for  a  year  or  to  foreclose.  Since  many  farm  mortgages 
are  held  by  outside  investors,  the  annoyance  is  sufficient  to 
reflect  itself  in  an  increased  rate  of  interest.  Because  of  this 
fact  many  bankers  are  urging  mixed  farming  as  a  means  of 
reducing  rates.  This  aspect  of  the  question  is  well  expressed 
in  a  communication  from  a  banker  in  Stark  County  who  says : 

It  is  our  belief  that  the  scarcity  of  money  and  the  high  interest 
rates  are  largely  due  to  poor  farming.  The  people  having  money 
to  loan  know  well  that  our  farmers  here  have  a  very  uncertain 
income  according  to  their  present  methods  of  farming,  and  would 
expect  a  much  higher  rate  commensurate  with  the  risk  taken  when 
they  can  find  people  where  money  can  be  placed  more  safely.  As 
conditions  are  here  now,  some  people  have  not  paid  all  their  in- 
terest, for  at  least  three  or  sometimes  four  years.  In  the  older 
states,  like  Iowa  for  example,  where  people  farm  well,  interest  rates 
are  much  lower.  As  soon  as  our  farmers  can  show  that  they  are 
safe  and  will  take  care  of  their  obligations  promptly,  they  can 
command  the  lowest  interest  rates  that  may  exist.  We  believe  it 
more  necessary  to  work  on  better  farming  methods,  encouraging 
them,  than  on  better  interest  rates,  for  the  lower  interest  rates  are 
a  natural  consequence  of  better  farming. 

Another  factor  is  the  character  of  the  population.  One 
prominent  banker  says  of  North  Dakota  farmers :  "  They 
lack  a  sense  of  responsibility.  Farm  loans  require  constant 
care,  hence  high  rates."  Another  complaint  is :  "  Farmers 
are  careless  in  not  making  prompt  payment  or  renewals  of 
obligations."  Some  bankers  think  the  high  rates  due  to  too 
much  borrowing;  that  is,  too  much  liberality  in  the  loaning 


NORTH  DAKOTA  6oi 

of  money.  Injudicious  loaning  leads  to  extravagance,  and 
naturally  calls  for  high  rates  to  offset  the  risks  involved. 
One  banker  in  analyzing  the  situation  claims  that  the  legal 
restrictions  placed  on  the  loaning  power  of  banks  is  respon- 
sible for  unduly  high  rates.  In  support  of  this  view  it  might 
be  stated  that  while  the  total  farm  mortgages  in  the  state  in 
1910  reached  the  $50,000,000  mark,  the  power  to  loan  on  real 
estate  by  all  banks,  state  and  national,  was  less  than  $5,- 
000,000.  Banks  are  forced  to  loan  on  the  personal  note  of 
the  farmer,  secured  by  a  mortgage,  instead  of  taking  a  direct 
mortgage  on  the  property.  Other  banks  turn  these  mortgage 
loans  over  to  trust  companies,  and  collect  a  commission  from 
the  farmer  for  placing  the  mortgage. 

Commissions  are  responsible  for  at  least  from  one  to  two 
per  cent,  of  the  rate  when  loans  are  handled  by  real  estate 
agents  and  loan  companies.  In  the  case  of  loans  by  life  in- 
surance companies,  the  state  agent  generally  receives  one  per 
cent,  and  the  local  agent,  at  interior  points,  receives  one  per 
cent.  Two  per  cent,  could  be  saved  by  the  farmer  if  the 
money  could  be  borrowed  directly  from  the  investor,  without 
the  aid  of  an  agent. 

Allowing,  however,  for  all  these  local  conditions  —  the 
great  demand  for  capital  in  a  new  and  developing  country, 
the  inability  to  attract  sufficient  outside  capital  because  of  the 
risky  character  of  investments,  the  irresponsible  character  of 
some  elements  in  the  population,  the  character  of  farming 
methods,  the  commission  agent,  and  the  legal  restrictions 
handicapping  banks  —  allowing  for  all  these  conditions,  and 
because  of  some  of  them,  it  is  believed  that  the  farmers  by 
organizing  co-operative  credit  associations  could  reduce  the 
rate  of  interest  on  both  long-  and  short-time  loans :  and,  fur- 
thermore, that  such  co-operative  credit  facilities  would  be  a 
means  of  improving  the  methods  of  farming,  would  encourage 
stability  in  population,  and  would  make  the  farmer  feel  that 
he  is  not  being  discriminated  against  in  the  borrowing  and 
employment  of  capital. 


602        AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 


CATTLE  LOAN  BANKS  1 

Consumers  desiring  a  reduction  in  the  cost  of  food  sup- 
plies will  be  interested  in  a  study  of  the  operations  of  cattle 
loan  companies  and  in  the  development  which  these  may  rea- 
sonably attain  as  a  result  of  the  provision  in  the  Federal 
Reserve  Act  for  the  rediscounting  of  agricultural  paper. 

The  cattle  loan  company,  commonly  referred  to  as  "  cattle 
bank,"  is  a  middleman  between  borrowing  cattle-owners  and 
lending  bank-managers.  Its  business  methods  and  forms 
closely  parallel  those  of  real  estate  mortgage  loan  companies 
except  for  the  fact  that  cattle  loans  are  of  shorter  duration 
and  secured  by  mortgages  of  the  chattel  variety.  Cattle  loan 
companies,  incorporated  under  state  charters,  have  been  oper- 
ating in  such  cities  as  Fort  Worth,  Denver,  East  St.  Louis, 
St.  Joseph,  Portland,  South  St.  Paul,  Omaha  (2),  and 
Kansas  City  (3),  some  of  them  for  over  twelve  years;  and 
one  is  now  being  organized  in  Chicago.  These  companies 
have  a  paid-in  capital  stock  ranging  from  $50,000  to  $300,000, 
and  are  usually  closely  affiliated  with  a  national  or  state 
bank,  as  are  trust  companies  in  the  larger  cities. 

These  companies  are  informed  of  desired  loans  through 
country  bankers,  or  by  receipt  of  direct  applications,  the  latter 
usually  from  the  larger  "  cattle-growlers."  In  some  cases  the 
company  on  its  own  initiative  urges  cattlemen  in  whom  it  has 
particular  confidence  to  undertake  feeding  operations  at  a  time 
when  the  beef  market  offers  a  favorable  opportunity  for  such 
production.  In  every  case  a  salaried  examiner  of  the  com- 
pany inspects  the  plant  and  herd  of  the  cattle-grower  and  his 
personal  capacity  and  integrity  before  the  granting  of  a  loan. 
And  thereafter  the  examiner,  on  his  regular  circuit,  maintains 
a  continuous  inspection  and  volunteers  advice  designed  to  pro- 
tect the  value  of  the  security  given  for  the  loan.  When  a  loan 
application  has  been  acted  upon  favorably,  a  promissory  note 
and  chattel  mortgage  are  taken.  The  funds  of  the  company 
then  advanced  to  the  borrowers  may  be  utilized  to  buy  more 

1  J.  F.  Ebersole,  Cattle  Loan  Banks,  The  Journal  of  Political  Economy, 
Vol.  22,  No.  6,  June,  1914,  pp.  577-580, 


CATTLE  LOAN  BANKS  603 

cattle,  to  pay  outstanding  debts  such  as  those  for  feeding  ex- 
pense, or,  as  is  often  the  case,  to  buy  the  very  cattle  which 
are  pledged  as  security  for  the  loan.  In  a  few  cases  where 
the  cattle-grower  enjoys  an  exceptional  credit,  funds  will  be 
advanced  for  the  full  purchase  price  of  a  herd  for  seasonal 
feeding  purposes,  or  to  develop  two-year-olds  into  finished 
four-year-old  beef  cattle.  The  loans  granted  are  seldom  less 
than  60  per  cent,  of  the  known  value  of  the  cattle. 

To  secure  a  buyer  for  the  note  and  mortgage  is  the  second 
primary  function  of  the  cattle  loan  company.  If  the  loan  is 
a  small  one,  usually  $10,000,  it  may  be  sold  entire,  the  chattel 
mortgage  assigned  and  the  note  indorsed  to  the  buyer.  If 
the  loan  is  a  larger  one,  of  $50,000  to  $100,000,  it  is  necessary 
to  subdivide  it  in  order  to  provide  a  ready  sale.  The  mort- 
gage and  note  are  assigned  in  parts  of  $5,000,  $20,000,  or 
other  denominations,  to  suit  the  convenience  of  the  buyers  of 
the  paper.  In  this  case  the  assigned  parts,  since  they  are  in- 
dorsed by  the  loan  company,  are  equivalent  to  a  "  debenture  " 
issue  secured  by  a  pledge  of  specified  assets  held  by  the  com- 
pany for  the  protection  of  the  note-holders.  The  size  of 
mortgage  loan  most  frequently  made  is  $10,000,  while  loans 
of  $100,000  are  exceptional. 

The  business  of  cattle  loan  companies  approaches  closely  to 
the  functions  of  the  commercial  paper  broker.  The  cattle  loan 
company  has  an  advantage  over  the  commercial  paper  broker 
in  that  the  favorable  location  of  the  company  —  always  at 
the  receiving  cattle-market  of  the  district  in  which  its  loans 
are  exclusively  placed  —  enables  it  fully  to  protect  its  interest 
by  claiming  the  proceeds  of  sales  of  mortgaged  cattle.  This 
is  particularly  true  in  the  case  of  range  cattle,  which  can  be 
readily  identified  by  the  mortgaged  brands. 

To  cover  expenses  of  administration  the  cattle  loan  com- 
pany secures  for  itself  a  part  of  the  interest  paid  on  the  loan. 
The  rate  charged  the  borrower  is  usually  determined  by  con- 
ditions in  the  locality  where  it  is  made,  sometimes  running  as 
high  as  10  per  cent.,  and  again,  influenced  by  general  rates  for 
capital,  falling  as  low  as  7  per  cent.  From  this  gross  interest 
charge  a  commission  has  to  be  given  to  the  local  banker  who 
makes  the  loan,  expenses  of  examination  and  management 


604        AGRICULTURAL  CREDIT  IN  THE  UNITED  STATES 

must  be  met,  and  an  appropriation  made  to  a  contingency  re- 
serve fund  to  cover  occasional  losses  incurred  from  the  cir- 
cumstance that  the  companies  usually  become  surety,  by  in- 
dorsement, for  the  final  payment  of  all  the  loans  which  they 
have  placed  with  lenders.  These  deductions  determine  what 
may  be  safely  paid  to  eastern  purchasers  of  the  paper,  usually 
5  or  6  per  cent. 

Holders  of  cattle  paper  have  never  suffered  in  times  of 
financial  panic  from  failure  to  pay  at  maturity.  Cattle,  like 
grain,  are  a  cash  commodity  purchased  by  retailers  and  sold  by 
them,  largely  for  cash,  to  satisfy  a  relatively  constant  consum- 
ing demand.  This  characteristic  is  retained  even  in  time  of 
panic. 

Maturities  are  usually  six  months  for  feeding  purposes; 
and  less  often  of  two  and  one-half  years  for  developing  two- 
year-olds  for  market.  This  two  and  one-half  year  paper  is 
occasionally  converted  into  the  six-month  variety  by  the  sale 
of  notes  running  for  six  months,  based  upon  the  two-and-one- 
half  year  mortgage.  These  notes  are  taken  up  at  maturity  by 
the  loan  company  and  reissued  or  renewed  for  like  succeeding 
periods  until  the  original  loan  is  repaid. 

In  the  past  this  form  of  loan  has  not  been  so  desirable  as  it 
will  be  in  the  near  future.  It  has  been  a  relatively  long-term 
investment ;  and  while  perfectly  liquid  at  maturity  and  enjoy- 
ing a  good  rate  of  return,  it  has  not  possessed  a  sufficiently 
wide  market  to  insure  salability  at  those  times  when  the  de- 
mands of  depositors  and  local  customers  for  accommodation 
press  in  upon  the  investing  bank.  This  difficulty  will  be  fully 
corrected  by  the  expected  operations  of  the  Federal  Reserve 
Act.  Eastern  bankers  possessing  these  six-month  notes  will 
probably  find  them  readily  rediscountable  with  the  local  federal 
reserve  bank  at  any  time  up  to  maturity.  And  a  considerable 
amount  of  two-and-one-hal  f  year  notes  may  be  held  to  ad- 
vantage, since,  if  properly  selected  with  successive  maturities, 
one-fifth  of  their  total  amount  will  be  immediately  rediscount- 
able  when  necessary. 

By  rendering  this  form  of  agricultural  paper  liquid  before 
maturity  the  Federal  Reserve  Act  will  have  become  a  most 
important  influence  for  enlarging  the  amount  of  capital  de- 


CATTLE  LOAN  BANKS  605 

voted  to  this  branch  of  industry.  Already  eastern  bankers 
have  scouts  touring  the  Western  States  to  study  this  form  of 
banking  with  a  view  to  investing  several  millions  of  dollars 
each.  Interest  rates  upon  these  loans  will  unquestionably  be 
reduced  in  time  through  such  increased  competition  of  lenders. 
The  loan  companies  will  hardly  suffer,  however.  While 
charging  the  cattle-grower  less,  they  will  be  enjoying  a  larger 
turnover  and  should  welcome  this  new  development.  The 
four  or  five  million  dollars  placed  in  such  loans  yearly  by  the 
average  loan  company,  as  at  present  constituted,  is  but  a  frac- 
tion of  the  loans  that  may  be  placed  by  them  within  a  few 
years. 

By  reducing  the  interest  cost  charged  to  cattle-growers  an 
important  service  will  have  been  performed  for  the  consumer. 
Such  a  reduction  will  increase,  in  the  first  instance,  the  cattle- 
man's profit  and  induce  him  to  increase  his  holdings.  The 
benefit  of  increased  production  at  lowered  expense  should,  in 
time,  be  passed  on  to  the  final  consumer  of  beef. 

This  phase  of  the  operations  of  the  Federal  Reserve  Act 
will  be  of  distinct  benefit,  and  possibly  also  the  least  dangerous 
of  all  forms  of  legislation  designed  to  assist  American  agri- 
culture. 


CHAPTER  XXVIII 

THE  CONCENTRATION  OF  CONTROL  OF 
MONEY  AND  CREDIT 

HAVE  WE  A  MONEY  TRUST? 
1  IF  by  a  "  money  trust  "  is  meant  — 

An  established  and  well-defined  identity  and  community  of  in- 
terest between  a  few  leaders  of  finance  which  has  been  created  and 
is  held  together  through  stock  holdings,  interlocking  directorates, 
and  other  forms  of  domination  over  banks,  trust  companies,  rail- 
roads, public-service  and  industrial  corporations,  and  which  has 
resulted  in  a  vast  and  growing  concentration  of  control  of  money 
and  credit  in  the  hands  of  a  comparatively  few  men  — 

your  committee  has  no  hesitation  in  asserting  as  the  result  of 
its  investigation  that  this  condition,  largely  developed  within 
the  past  five  years,  exists  in  this  country  to-day. 

The  parties  to  this  combination  or  understanding  or  com- 
munity of  interest,  by  whatever  name  it  may  be  called,  may  be 
conveniently  classified,  for  the  purpose  of  differentiation,  into 
four  separate  groups. 

First.  The  first,  which  for  convenience  of  statement  we 
will  call  the  inner  group,  consists  of  J.  P.  Morgan  &  Co.,  the 
recognised  leaders,  and  George  F.  Baker  and  James  Stillman 
in  their  individual  capacities  and  in  their  joint  administration 
and  control  of  the  First  National  Bank,  the  National  City 
Bank,  the  National  Bank  of  Commerce,  the  Chase  National 
Bank,  the  Guaranty  Trust  Co.,  and  the  Bankers  Trust  Co., 
with  total  known  resources,  in  these  corporations  alone,  in 
excess  of  $1,300,000,000,  and  of  a  number  of  smaller  but  im- 
portant financial  institutions.  This  takes  no  account  of  the 
personal  fortunes  of  these  gentlemen. 

1  Adapted  from  the  Report  of  ihe  Committee  Af> pointed  to  Investigate 
the  Concentration  of  Control  of  Money  and  Credit,  62d  Congress,  3d  Ses- 
sion, pp.  130-33. 

606 


HAVE  WE  A  MONEY  TRUST?  607 

Second.  Closely  allied  with  this  inner  or  primary  group, 
and  indeed  related  to  them  practically  as  partners  in  many  ot" 
their  larger  financial  enterprises,  are  the  powerful  interna- 
tional banking  houses  of  Lee,  Higginson  &  Co.  and  Kidder, 
Peabody  &  Co.,  with  three  affiliated  banks  in  Boston  —  the 
National  Shawmut  Bank,  the  First  National  Bank,  and  the 
Old  Colony  Trust  Co.  —  having  at  least  more  than  half  of  the 
total  resources  of  all  the  Boston  banks;  also  with  interests  and 
representation  in  other  important  New  England  financial  in- 
stitutions. 

Third.  In  New  York  City  the  international  banking  house 
of  Messrs.  Kuhn,  Loeb  &  Co.,  with  its  large  foreign  clientele 
and  connections,  whilst  only  qualifiedly  allied  with  the  inner 
group,  and  only  in  isolated  transactions,  yet  through  its  close 
relations  with  the  National  City  Bank  and  the  National  Bank 
of  Commerce  and  other  financial  institutions  with  which  it  has 
recently  allied  itself  has  many  interests  in  common,  conducting 
large  joint-account  transactions  with  them,  especially  in  recent 
years,  and  having  what  virtually  amounts  to  an  understanding 
not  to  compete,  which  is  defended  as  a  principle  of  "  banking 
ethics."  Together  they  have  with  a  few  exceptions  pre-empted 
the  banking  business  of  the  important  railways  of  the  country. 

Fourth.  In  Chicago  this  inner  group  associates  with  and 
makes  issues  of  securities  in  joint  account  or  through  under- 
writing participations  primarily  with  the  First  National  Bank 
and  the  Illinois  Trust  &  Savings  Bank,  and  has  more  or  less 
friendly  business  relations  with  the  Continental  &  Commercial 
National  Bank,  which  participates  at  times  in  the  underwriting 
of  security  issues  by  the  inner  group.  These  are  the  three 
largest  financial  institutions  in  Chicago,  with  combined  re- 
sources (including  the  two  affiliated  and  controlled  state  in- 
stitutions of  the  two  national  banks)  of  $561,000,000. 

Radiating  from  these  principal  groups  and  closely  affiliated 
with  them  are  smaller  but  important  banking  houses,  such  as 
Kissel  Kinnicut  &  Co.,  White,  Weld  &  Co.,  and  Harvey  Fisk 
&  Sons,  who  receive  large  and  lucrative  patronage  from  the 
dominating  groups  and  are  used  by  the  latter  as  jobbers  or  dis- 
tributors of  securities  the  issuing  of  which  they  control,  but 
which  for  reasons  of  their  own  they  prefer  not  to  have  issued 


608  CONTROL  OF  MONEY  AND  CREDIT 

or  distributed  under  their  own  names.  Messrs.  Lee,  Higgin- 
son  &  Co.,  besides  being  partners  with  the  inner  group,  are 
also  frequently  utilised  in  this  service  because  of  their  facilities 
as  distributors  of  securities. 

Beyond  these  inner  groups  and  subgroups  are  banks  and 
bankers  throughout  the  country  who  co-operate  with  them  in 
underwriting  or  guaranteeing  the  sale  of  securities  offered  to 
the  public  and  who  also  act  as  distributors  of  such  securities. 
It  was  impossible  to  learn  the  identity  of  these  corporations, 
owing  to  the  unwillingness  of  the  members  of  the  inner  group 
to  disclose  the  names  of  their  underwriters,  but  sufficient  ap- 
pears to  justify  the  statement  that  there  are  at  least  hundreds 
of  them  and  that  they  extend  into  many  of  the  cities  through- 
out this  and  foreign  countries. 

The  patronage  thus  proceeding  from  the  inner  group  and 
its  subgroups  is  of  great  value  to  these  banks  and  bankers, 
who  are  thus  tied  by  self-interest  to  the  great  issuing  houses 
and  may  be  regarded  as  a  part  of  this  vast  financial  organisa- 
tion. Such  patronage  yields  no  inconsiderable  part  of  the  in- 
come of  these  banks  and  bankers  and  without  much  risk  on 
account  of  the  facilities  of  the  principal  groups  for  placing 
issues  of  securities  through  their  domination  of  great  banks 
and  trust  companies  and  their  other  domestic  affiliations  and 
their  foreign  connections.  The  underwriting  commissions  on 
issues  made  by  this  inner  group  are  usually  easily  earned  and 
do  not  ordinarily  involve  the  underwriters  in  the  purchase  of 
the  underwritten  securities.  Their  interest  in  the  transaction 
is  generally  adjusted,  unless  they  choose  to  purchase  part  of 
the  securities,  by  the  payment  to  them  of  a  commission. 
There  are,  however,  occasions  on  which  this  is  not  the  case. 
The  underwriters  are  then  required  to  take  the  securities. 
Bankers  and  brokers  are  so  anxious  to  be  permitted  to  par- 
ticipate in  these  transactions  under  the  lead  of  the  inner  group 
that  as  a  rule  they  join  when  invited  to  do  so,  regardless  of 
their  approval  of  the  particular  business,  lest  by  refusing  they 
should  thereafter  cease  to  be  invited. 

It  can  hardly  be  expected  that  the  banks,  trust  companies, 
and  other  institutions  that  are  thus  seeking  participations  from 
this  inner  group  would  be  likely  to  engage  in  business  of  a 


HAVE  WE  A  MONEY  TRUST?  609 

character  that  would  be  displeasing  to  the  latter  or  that  would 
interfere  with  their  plans  or  prestige.  And  so  the  protection 
that  can  be  offered  by  the  members  of  this  inner  group  con- 
stitutes the  safest  refuge  of  our  great  industrial  combinations 
and  railroad  systems  against  future  competition.  The  power- 
ful grip  of  these  gentlemen  is  upon  the  throttle  that  controls 
the  wheels  of  credit  and  upon  their  signal  those  wheels  will 
turn  or  stop. 

In  the  case  of  the  pending  New  York  subway  financing  of 
$170,000,000  of  bonds  by  Messrs.  Morgan  &  Co.  and  their 
associates,  Mr.  Davison  estimated  that  there  were  from  100 
to  125  such  underwriters  who  were  apparently  glad  to  agree 
that  Messrs.  Morgan  &  Co.,  the  First  National  Bank,  and  the 
National  City  Bank  should  receive  3  per  cent.* — equal  to  $5,- 
100,000 — for  forming  this  syndicate,  thus  relieving  them- 
selves from  all  liability,  whilst  the  underwriters  assumed  the 
risk  of  what  the  bonds  wrould  realise  and  of  being  required  to 
take  their  share  of  the  unsold  portion.  This  transaction  fur- 
nishes a  fair  illustration  of  the  basis  on  which  this  inner  group 
is  able  to  capitalise  its  financial  power. 

It  may  be  that  this  recently  concentrated  money  power  so 
far  has  not  been  abused  otherwise  than  in  the  possible  exaction 
of  excessive  profits  through  absence  of  competition.  Whilst 
no  evidence  of  abuse  has  come  to  the  attention  of  the  com- 
mittee from  impartial  sources,  neither  has  there  been  adequate 
proof  or  opportunity  for  proof  on  the  subject.  Here  again 
the  data  have  not  been  available. 

Sufficient  has,  however,  been  developed  to  demonstrate  that 
neither  potentially  competing  banking  institutions  nor  compet- 
ing railroad  or  industrial  corporations  should  be  subject  to  a 
common  source  of  private  control. 

Your  committee  is  convinced  that  however  well  founded 
may  be  the  assurances  of  good  intentions  by  those  now  holding 
the  places  of  power  which  have  been  thus  created,  the  situation 
is  fraught  with  too  great  peril  to  our  institutions  to  be  toler- 
ated. 


6lO  CONTROL  OF  MONEY  AND  CREDIT 


THE  BORROWER  AND  THE  MONEY  TRUST 

1  Some  trusts  are  denounced  because  of  their  attitude  to- 
ward their  employes.  Many  trusts  are  efficient  or  inefficient 
because  of  the  way  their  millions  of  labourers  work.  But  let 
us  be  fair  to  Big  Business.  Why  not  examine  its  one  branch 
where  labour  is  almost  absent,  where  there  is  no  brawn  and 
all  brain? 

BANKING   THE    MOST   LOGICAL   OF   TRUSTS 

A  bank  in  New  York  City  gave  its  employes  a  Christmas 
present  equal  to  half  their  annual  salary.  The  bank  had  assets 
of  $100,000,000.  A  fine  example,  you  say,  to  other  great 
business  concerns!  But  the  bank  had  only  fi-fty  employes. 
In  the  entire  country  there  are  probably  not  more  than  100,000 
persons  engaged  in  banking,  either  directly  or  indirectly. 

The  banker  has,  relatively  speaking,  no  human  factor  to 
consider.  And  that  factor  with  a  concern  like  the  United 
States  Steel  Corporation  or  the  Pennsylvania  Railroad  is 
mammoth,  almost  baffling.  The  banker  deals  not  in  the  pro- 
duction or  distribution  of  wealth  itself  (in  both  of  which 
much  labor  is  needed),  but  solely  in  the  paper  representatives 
of  wealth,  money,  and  credit.  Thus  he  can  apply  far  more 
directly  than  the  manufacturer  or  railroad  manager  the  econo- 
mies and  efficiencies  of  Big  Business. 

Banking  —  the  business  of  dealing  in  money  and  credit  — 
is  the  most  logical  of  trusts.  And  in  practice  it  has  justified 
the  theory.  Where  banks  have  become  larger  they  have  be- 
come stronger,  where  co-operation  and  concentration  have 
gone  far,  there  safety  and  effectiveness  have  reached  a  high 
pitch.  .  .  .  Banking  is  the  one  central  business  of  all  —  it  is 
the  business  of  businesses.  So  if  it  has  become  more  efficient 
as  the  trust  idea,  or  at  least  the  principle  of  concentration,  has 
gained  sway,  how  can  we  have  too  much  concentration  and 
who  is  there  to  complain  ?  .  .  . 

If  the  bankers  have,  faithfully  and  well,  handled  the  trust 

1  Adapted  from  Albert  W.  Atwood.  The  Borrower  and  the  Money  Trust, 
Review  of  Reviews,  Vol  46,  August.  iQt2,  pp   207-218. 


WHERE  THE  MONEY  HAS  GONE         6ll 

of  extending  credit  to  the  limit  of  their  ability,  yet  when  the 
president  of  the  second  bank  in  size  in  the  country  acknowl- 
edges himself  to  be  one  of  about  a  dozen  men  in  whose  hands 
the  power  of  extending  credit  is,  in  the  last  analysis,  concen- 
trated —  then  it  is  high  time,  seriously  and  fearlessly,  to  con- 
sider the  subject.  .  .  . 

Three  main  factors  are  in  the  main  responsible  for  the  con- 
centration of  the  control  of  credit  and  they  are  the  growth  of 
big  banks,  the  growth  of  big  industries,  and  the  financial  laws 
of  the  country.  .  .  . 

NO   LACK   OF   BANKING   FACILITIES 

However  great  the  concentration  of  money  power  in  this 
country,  it  cannot  truthfully  be  said  that  banking  facilities  are 
not  also  increasing.  Figures  taken  from  the  reports  of  the 
National  Monetary  Commission  and  other  official  sources  show 
that  the  number  of  banks  is  mounting  up  faster  than  either 
wealth  or  population.  .  .  . 

WHERE   THE    MONEY   HAS   GONE 

When  one  first  realises  the  extent  of  this  country's  banking 
resources  he  is  properly  astonished.  But  how  evenly  are  these 
resources  distributed?  It  is  commonly  known  that  banking 
facilities  in  the  Southern  and  Western  sections  of  the  country 
are  small  indeed  as  compared  with  the  New  England,  Eastern, 
Central,  and  Pacific  Coast  sections,  where  large  cities  abound. 
To  illustrate,  in  1909,  when  the  total  banking  power  was  close 
to  twenty-one  billions,  more  than  half  was  represented  by 
forty-seven  cities,  and  close  to  one-quarter  was  held  by  the  two 
hundred  banks  in  New  York  and  Chicago.  In  other  words 
about  I  per  cent,  of  the  country's  banks  held  close  to  one- 
quarter  of  the  country's  banking  power. 

Now  it  is  a  well-known  fact  that  an  individual  or  corpora- 
tion with  large  resources  and  large  business  exerts  an  influence 
in  his  particular  field  far  in  excess  of  his  actual  mathematical 
percentage  of  the  total  resources  or  business.  Thus  the  domi- 
nating position  of  the  big  banks  is  even  greater  than  mere 
figures  indicate.  But  there  is  still  another  fact  which  cen- 

o 

tralises  and  cements  their  power.     The  only  banks  which  are 


6l2  CONTROL  OF  MONEY  AND  CREDIT 

really  large  are  in  a  few  cities,  and  the  larger  they  are,  the 
more  they  tend  to  the  very  greatest  centres  of  population. 
Thus  toward  the  end  of  1911,  there  were  183  banking  institu- 
tions with  deposits  of  $10,000,000  or  more,  of  which  sixty-two 
were  in  New  York  City.  There  were  thirty-six  institutions 
with  deposits  of  $25,000,000  or  more.  Sixteen  of  these  were 
in  New  York  City  and  four  in  Chicago.  There  were  ten  with 
deposits  of  $75,000,000  or  more,  and  of  these,  seven  were  in 
New  York  and  two  in  Chicago.  Of  the  ten  largest  trust  com- 
panies six  were  in  New  York,  three  in  Chicago,  and  one  in 
Boston. 

These  great  banks  and  trust  companies  are  of  very  recent 
growth.  Twenty  years  ago  the  deposits  of  our  largest  bank 
were  one-twentieth  of  what  they  are  to-day.  At  the  first  in- 
auguration of  President  McKinley,  which  was  really  not  so 
far  back  as  the  Dark  Ages,  there  was  no  bank  in  New  York 
with  more  than  $30,000,000  of  deposits.  Now  there  are  six 
banks  each  with  more  than  $100,000,000  of  deposits.  A  trust 
company  in  New  York  City,  which  had  deposits  of  $20,000,- 
ooo  five  years  ago,  now  has  deposits  of  $166,000,000  and  its 
twenty-eight  directors  sit  [1912]  in  boards  of  other  banking 
institutions  with  resources  of  $1,250,000,000.  When  it  comes 
to  actual  cash  we  find  the  position  of  the  New  York  and  Chi- 
cago banks  even  more  dominant.  .  .  . 

CONSOLIDATION A   STEADY   PROCESS 

Despite  the  disproportionate  size  of  New  York  and  Chicago 
banks  their  number  is  steadily  decreasing.  This  is  because  the 
process  of  consolidation  proceeds  just  as  steadily.  In  1853 
there  were  fifty-three  banks  in  the  New  York  Clearing  House 
Association,  and  in  1911  there  were  fifty,  although  in  the 
meantime  the  amount  of  business  had  increased  twenty  times. 
There  are  now  less  than  130  banks  in  New  York,  or  ten  less 
than  ten  years  ago,  although  in  that  time  cash  holdings  have 
doubled  and  deposits  have  increased  a  third.  In  ten  years  no 
less  than  103  banks  have  gone  out  of  existence,  generally 
through  absorption  into  larger  institutions.  ...  In  Chicago 
the  same  process  of  consolidation  has  gone  on.  One  Chicago 
trust  company  has  absorbed  six  others  in  eight  years. 


AFFILIATION  FOSTERED  613 

New  York  and  Chicago  are  by  no  means  the  only  cities  in 
which  the  obvious  tendency  is  to  have  fewer  but  larger  banks. 
Look  about  at  random.  Akron,  Ohio,  where  the  rubber  in- 
dustry has  recently  become  of  more  than  local  importance,  has 
felt  the  necessity  of  banks  large  enough  to  carry  on  its  trade, 
and  consolidation  has  resulted.  In  Detroit,  where  the  auto- 
mobile trade  has  set  in  motion  a  great  industrial  development, 
the  Old  Detroit  National  has  absorbed  the  American  Exchange 
National.  In  Seattle,  Nashville,  Wilmington,  Portland,  Phil- 
adelphia, Baltimore,  San  Francisco,  and  Louisville  there  have 
been  many  recent  mergers  and  absorptions.  In  Cincinnati 
one  of  the  largest  institutions  in  the  Ohio  Valley  has  been 
formed  by  the  absorption  of  the  Merchants'  National  by  the 
First  National.  As  for  Boston  the  desire  of  her  capitalists  to 
make  New  England  more  powerful  in  the  business  life  of  the 
country  has  led  to  the  recent  absorption  of  the  City  Trust 
Company  by  the  Old  Colony  and  the  steady  growth  of  three 
financial  institutions,  the  Shawmut  National  Bank,  the  First 
National  Bank,  and  the  Old  Colony  Trust  Company,  these 
three  far  exceeding  all  others  in  size.  .  .  . 

HOW    THE   LAW    HAS    FOSTERED   AFFILIATION 

.  .  .  One  great  cause  of  the  concentration  of  banking  and 
financial  power  into  a  few  hands  has  been  the  consolidation  of 
banking  resources  into  a  few  great  units  and  the  friendly 
affiliations  of  these  units.  But  these  units  have  not  gro\vn 
big  merely  because  their  managers  or  owners  willed  it  so. 
The  banking  and  currency  laws  of  the  country  have  forced 
money  into  a  few  centres.  The  banks  of  New  York  City  em- 
ploy—  mainly  in  financial  or  stock  market  loans  —  about 
$600,000,000  which  belongs  to  banks  in  other  parts  of  the 
country.  Naturally  this  concentration  of  money  in  a  few 
banks  "  places  these  banks  in  a  position  to  control  the  issuing 
or  granting  of  credit  "•  -  to  use  the  exact  words  of  the  presi- 
dent of  one  of  them — "thereby  placing  the  money  power  in 
the  hands  of  a  comparatively  small  number  of  men." 

But  this  gravitation  of  money  to  New  York  is  because  the 
money  is  idle  and  is  hunting  a  job,  and  not  because  of  any 
process  of  usurpation,  manipulation,  or  combination.  It  nat- 


614  CONTROL  OF  MONEY  AND  CREDIT 

urally  arises  under  and  by  virtue  of  the  reserve  requirements 
of  our  National  Banking  Act.  .  .  .  The  bulk  of  idle  country 
bank  cash  which  finds  employment  in  New  York  conies  here 
because  of  the  existing  reserve  system,  and  there  are  several 
great  banks  in  both  New  York  and  Chicago  which  have  few 
customers  other  than  the  thousands  of  country  banks  whose 
"  correspondents  "  they  are. 

THE    CORPORATION    AND   THE   BANK 

Thus  banking  and  financial  power  is  concentrated  in  a  few 
hands  not  only  by  the  growth  of  great  banks  and  by  the  laws 
of  the  country,  but  also  by  the  legitimate  business  practices 
which  have  grown  up  under  these  laws.  But  the  massing  of 
this  power  in  a  few  vast,  centralised  units  has  been  a  develop- 
ment of  the  last  ten  or  fifteen  years  only.  That  is,  it  has  been 
coincident  with  the  development  of  trusts  and  'combinations. 
Big  Business  and  Big  Banking  have  gone  hand  in  hand.  Each 
has  made  the  other  possible.  By  law  a  bank  cannot  loan  more 
than  one-tenth  of  its  capital  and  surplus  to  any  one  customer. 
But  the  customers  have  grown  into  behemoths.  How  then 
could  the  banks  fail  to  grow  ? 

Before  trusts  existed  and  before  small  railroads  were  united 
into  large  systems  the  few  banking  houses  of  magnitude  which 
existed  in  Wall  Street  had  engaged  in  merchant  banking,  for 
the  industries  and  railroads  had  not  been  large  enough  to  at- 
tract their  attention.  These  small  industries  and  railroads 
were  controlled  by  their  owners,  and  their  capital  requirements 
were  supplied  largely  in  the  localities  in  which  they  were 
situated.  But  as  railroads  and  industries  were  consolidated 
it  was  found  necessary  to  apply  to  the  larger  New  York 
banking  firms  to  supply  the  funds.  These  bankers  had  Euro- 
pean connections  as  well  as  close  affiliations  with  the  big  na- 
tional banks  and  life  insurance  companies,  and  were  able  not 
only  to  furnish  the  needed  capital  but  also  undertook  to  market 
the  securities  of  the  newly  formed  combinations. 

Thus  a  few  banking  houses,  of  which  J.  P.  Morgan  & 
Co.  is  the  chief  example,  became  in  a  way  responsible  for 
these  new  creations  and  naturally  assumed  charge  not  only  of 
their  finances,  but  to  some  extent  of  their  other  affairs.  Thus 


THE  CORPORATION  AND  THE  BANK        615 

the  headquarters  of  the  trusts  and  railroads  gradually  moved 
to  New  York.  In  the  treasuries  of  these  companies  were  vast 
sums  of  money  to  be  banked,  and  it  was  inevitable  that  most 
of  it  should  be  placed  in  New  York  banks.  The  average 
daily  balance  of  the  United  States  Steel  Corporation  is  about 
$75,000,000  and  the  American  Tobacco  Company  has  perhaps 
$20,000,000.  There  is  also  the  Standard  Oil  Company,  whose 
balance  is  perhaps  as  large. 

These  few  financial  groups,  J.  P.  Morgan  &  Co.,  Kuhn, 
Loeb  &  Co.,  and  the  capitalists  identified  with  the  National 
City  Bank  and  the  First  National  Bank,  along  with  a  few 
others,  are  primarily  in  the  business  of  selling  securities  and 
loaning  money  upon  them.  In  fact  they  may  be  described  as 
the  great  security  issuing  houses.  Such  influence  as  their 
members  or  directors  may  exert  over  railroad  and  other  cor- 
porations is  largely  due  to  their  ability  to  dispose  of  securities 
and  to  give  these  securities  the  stamp  of  soundness  and  con- 
servatism. Here  it  may  be  added  that  men  like  J.  P.  Morgan 
would  not  be  directors  in  so  many  corporations  if  their  ad- 
vice and  assistance  were  not  eagerly  sought. 

In  the  small  village  a  small  group  of  men  own  the  bank, 
the  coal  yard,  the  ice-plant,  the  trolley  line,  the  gas  plant,  and 
the  little  factories.  Every  day  of  the  year  these  men,  in  their 
different  capacities,  have  to  trade  with  themselves  in  the  pur- 
chase of  supplies,  etc.,  for  their  different  companies,  one  from 
another.  No  one  thinks  of  accusing  them  of  double  dealing, 
and  yet  the  situation  differs  not  a  whit  from  the  vast  system 
of  interlocking  bank  and  corporate  directors  in  New  York 
except  in  degree  and  in  fact,  which,  however,  is  vital,  that  the 
New  York  system  affects  the  whole  commonwealth  whereas 
the  business  convolutions  of  Deacon  Jones  of  Jones'  Corners 
do  not. 

Now  it  must  not  be  supposed  that  bankers  such  as  Mr. 
Morgan  and  his  partners  are  usually  large  owners  in  the  com- 
panies they  influence  or  even  control.  Often  they  do  not  own 
15  per  cent,  of  the  stock  of  the  banks  they  dominate.  Often 
they  become  directors  with  but  a  few  shares  of  qualifying 
stock.  Still  more  often  their  influence  is  exerted  merely  as 
financial  advisers.  Often  they  nominate  the  president  of  a 


6l6  CONTROL  OF  MONEY  AND  CREDIT 

railroad  or  manufacturing  company  as  Morgan  &  Co.  nomi- 
nated the  president  of  the  Atlas.  Portland  Cement  Company. 
Often  the  bankers  take  no  part  in  the  direction  of  companies 
until  these  companies  have  shown  incapacity  or  have  had  for 
any  reason,  business  or  governmental,  to  be  reorganised,  either 
in  form  or  management.  Recent  cases  which  come  under  one 
or  the  other  of  these  heads  are  the  Wabash  Railroad,  the 
.United  States  Motors  Co.,  the  Westinghouse  Electric  &  Manu- 
facturing Company,  the  International  Paper  Company,  the 
'American  .Tobacco  Company  and  the  American  Sugar  Re- 
fining Company. 

HARMONY   THE   WATCHWORD 

There  is  little  evidence  to  show  any  actual  agreement  or 
even  arrangement  among  the  great  financial  groups.  Through 
interlocking  directors  and.  the  wide  following  of  smaller  firms 
which  each  of  the  big  groups  has,  the  whole  big  banking  situa- 
tion in  New  York  is  closely  knit  together.  There  is  a  care- 
fully fostered  community  of  interest  even  among  hostile 
groups,  each  group  having  a  director  or  two,  like  a  financial 
ambassador,  in  the  other  banks.1  In  the  past  there  has  been 
keen  rivalry.  Historically  the  Morgan  and  First  National 
Bank  groups  have  long  been  close,  and  two  members  of  the 
Morgan  firm  were  taken  from  the  First  National  Bank.  At 
one  time  these  two  groups  bitterly  fought  the  other  two 
powerful  groups  —  the  Kuhn,  Loeb-National  City  Bank  in- 
terests. But  in  recent  years  harmony  has  prevailed.  .  .  . 

It  must  be  remembered  that  the  four  banking  groups  are 
now  managed  for  the  most  part  by  young  men.  These  young 
men  are  more  accustomed  to  the  ways  of  conciliation  than 
were  the  late  E.  H.  Harriman,  and  John  D.  Rockefeller  and 
J.  P.  Morgan.  The  younger  nien  trouble  themselves  little 
with  the  former  conflicts  of  Morgan,  Hill,  Rockefeller,  Scruff, 
Stillman,  Harriman,  and  Ryan.  They  have  forgotten  even 
the  accusations  and  charges  which  the  life  insurance  scandals 
made  public.  Their  aim  is  more  impersonal  —  it  is  to  "  de- 
velop business,"  and  the  surest  way  to  do  that  is  by  working 
harmoniously  together. 

1  [Interlocking  directorates  among  the  more  important  banks  were  pro- 
hibited by  the  Clayton  Act,  passed  in  1914.  See  p.  624.] 


CONCENTRATION  ELSEWHERE  617 


MONEY   POWER   NOT   DISTINCTLY   AMERICAN 

Striking  as  the  concentration  of  banking,  money,  and  finan- 
cial power  seems,  it  is  no  greater  here  than  abroad,  perhaps 
not  so  great.  In  London  there  are  banks  with  fifty  millions 
of  capital,  or  twice  as  much  as  our  one  largest  bank,  and  de- 
posits of  nearly  four  hundred  millions  of  dollars,  or  twice  as 
much  as  our  largest  bank.  Even  Canada,  with  a  population 
less  than  one-tenth  of  ours,  has  a  bank  as  great  as  our  greatest. 
Relatively  its  big  banks  are  bigger  than  ours.  Concentration 
in  Canada  has  gone  much  farther  than  here.  Six  banks  in 
the  Dominion  hold  half  its  entire  banking  resources.  The 
autocratic  power  wielded  by  the  score  of  great  Canadian 
banks  would  start  a  revolution  in  this  country.  Germany  and 
France  long  ago  went  through  the  process  of  bank  consolida- 
tion. 

WHY,   THEN,   DO  WE  HEAR  FEW   COMPLAINTS   FROM   ABROAD? 

Here  is  a  problem  to  be  faced  with  intellectual  honesty. 
Money  power  may  be  a  bad  thing,  but  let  us  not  be  so  dis- 
honest as  to  declare  it  a  new  thing.  The  New  York  Clearing 
House  Association  may  wield  power  too  autocratic,  but  let  it 
not  be  overlooked  that  a  similar  organisation  in  London,  with 
only  one-third  as  many  members,  has  long  exercised  as  great 
power  without  raising  any  hue  and  cry.  of  a  Money  Trust. 
Also  consider  Germany.  If  you  have  the  time  and  courage  to 
undertake  such  a  task,  go  through  the  ponderous  volume  is- 
sued by  the  National  Monetary  Commission  telling  of  the 
actual  results  of  the  great  bank  system  in  that  country.  It  is 
a  weary  task  reading  the  long-winded  testimony  of  Herr  Pro- 
fessor Doctor  Governor  this  and  that,  but  it  is  worth  the 
labour. 

We  are  told  that  great  banks  are  more  amenable  to  public 
opinion  than  smaller  scattered  institutions,  that  the  Govern- 
ment is  more  ably  assisted  in  its  financial  operations,  that 
fewer  reckless  loans  are  made.  Quicker  prognostication  of 
crises,  whether  on  the  Bourse  or  in  commerce  and  industry, 
quicker  adoption  of  preventive  measures  thereby  lessening 


6l8  CONTROL  OF  MONEY  AND  CREDIT 

the  effects  of  crises,  are  other  services  rendered  by  concen- 
trated banking  in  Germany.  .  .  . 

In  1907,  when  there  was  far  less  both  of  co-operation  and 
concentration  among  the  banks  of  this  country  than  there  is 
to-day,  each  bank  standing  weakly  isolated  and  alone,  franti- 
cally grasped  all  the  cash  it  could  muster.  When  the  panic 
storm  broke  banks  struggled  to  call  in  loans  and  line  their 
vaults  with  cash.  Business  was  crippled;  industry  was 
squeezed  dry  of  its  lifeblood.  Last  year  when  Germany  was 
threatened  with  both  war  and  panic,  trouble  was  averted  by  the 
German  "  Money  Trust,"  which  loaned  more  than  $200,- 
000,000.  It  takes  no  expert  knowledge  of  finance  or  banking 
to  perceive  that  a  few  great,  strong  banks,  or  many  smaller 
ones  (provided  they  are  welded  closely  together)  can  meet  a 
storm  more  calmly  than  scattered,  unconnected  institutions. 

WHERE   IS   THE   VITAL  DIFFERENCE? 

If  concentration  is  a  good  thing,  how  can  there  be  too  much 
of  it?  Here  is  the  answer.  Concentrated  power  without  re- 
sponsibility may  be  the  worst  possible  thing.  The  other  great 
financial  nations  have  money  trusts  .  .  .  too,  but  each  is 
capped  by  a  vast  central  bank,  more  or  less  a  government  in- 
stitution, and  from  the  necessity  of  the  case  operated  not  only 
with  a  view  to  the  general  welfare  but  more  or  less  openly  and 
publicly.  .  .  .  The  American  "  Money  Trust "  is  strictly  pri- 
vate, responsible  to  no  one.  It  may  act  philanthropically  if  it 
chooses,  but  it  is  governed  by  nothing  but  choice.  The  money 
kings  can,  if  they  wish,  exact  any  price. 

R.  H.  Thomas,  former  president  of  the  New  York  Stock 
Exchange,  told  the  Pujo  committee  how  Wall  Street  had 
finally  to  turn  to  one  man,  J.  P.  Morgan,  in  the  panic  of  1907, 
to  save  it  from  complete  disaster.  He  did  not  know  where 
the  relief  came  from,  in  what  form,  nor  with  what  conditions. 
It  just  came.  Since  at  that  time  the  entire  country  was  de- 
pendent upon  Wall  Street  because  its  surplus  money  was  there, 
there  is  no  escaping  the  fact  that  the  whole  financial  situation 
of  the  country  was  at  the  mercy  of  one  man.  A  200  per  cent, 
rate  for  loans  would  be  inconceivable  in  one  of  the  European 
financial  centres  because  the  central  banks  of  Europe  are  the 


BANKS  AND  THE  RAILWAYS  619 

guarantors  of  the  stability  of  the  money  market.  The  central 
banks  of  Europe  depend  upon  no  man,  selfish  or  altruistic. 
They  are  the  public  financial  regulators  of  the  whole  nation. 

Has  the  Money  Power  been  used  to  crush  and  squeeze  ?  .  .  . 
Suppose  that  it  has  not  been  so  used.  Nevertheless,  its  con- 
trol is  in  the  hands  of  a  few  men.  Even  if  their  action  be 
honest  and  intended  for  the  public  interest,  they  are  necessarily 
most  interested  in  the  great  undertakings  in  which  we  have 
seen  them  to  be  engaged.  By  reason  of  these  limitations  they 
must  check  and  limit,  if  they  do  not  destroy,  genuine  economic 
freedom  and  competition.  ...  A  handful  of  men,  responsible 
to  no  one  but  themselves  and  God,  have  become  masters  of 
the  lifeblood  of  commerce  and  industry.  That  this  power  has 
been  more  rapidly  concentrated  into  their  hands  than  the 
people  have  supposed  is  the  unavoidable  conclusion  of  this 
article. 

From  private  persons,  acting  in  private,  and  dominated  in 
the  main  by  private  motives  there  cannot  be  expected  the 
wisest  and  broadest  direction  of  the  flow  of  money  —  the  life- 
blood  of  business.  These  men  have  not  asked  for  this  power. 
They  know  it  is  too  great  for  them.  On  the  whole  they  have 
behaved  with  singular  restraint.  But  only  a  fool  would  sup- 
pose that  the  best  system  for  financing  the  small  farmer  in 
Florida  or  the  small  tin  can  manufacturer  in  Oregon  is  to  turn 
over  the  entire  money  power  of  the  nation  to  J.  P.  Morgan 
and  a  few  other  private  persons.  How  under  such  a  system 
could  the  great  trusts  fail  to  thrive  at  the  expense  of  the 
small  man  ? 

THE  BANKS  AND  RAILWAY  FINANCE 

1  Close  relationships  of  railways  with  banks  or  other  credit 
institutions  have  grown  up  naturally  through  the  need  for  new 
capital  constantly  imposed  upon  an  expanding  railway  system. 
Some  railways  have  been  fortunate  enough  to  possess  a  rela- 
tively stable  body  of  stockholders  whose  confidence  in  the 
management  is  so  complete  that  new  funds  can  be  raised  by 

i  Frank  Haigh  Dixon,  The  Economic  Significance  of  Interlocking  Direc- 
torates in  Railway  Finance,  The  Journal  of  Political  Economy,  Vol.  23, 
No.  2,  February,  1915,  pp.  938-946. 


620  CONTROL  OF  MONEY  AND  CREDIT 

direct  appeal  of  the  management  to  the  stockholders  without 
the  intervention  of  outside  financial  interests.  But  these  cases 
have  thus  far  been  rare  in  American  railway  finance.  When 
the  policy  calls  for  the  raising  of  funds  by  the  issuance  of 
bonds  rather  than  stock,  the  appeal  is  to  a  wider  and  to  an 
anonymous  public  rather  than  to  a  corporation's  own  stock- 
holders. Frequently  the  appeal  must  be  to  a  class  of  investors 
situated  in  another  section  of  the  country  or  even  in  a  foreign 
country.  Most  railways  have  not  the  technical  organization 
nor  the  established  market  necessary  to  handle  their  issues 
easily,  and  usually  it  is  found  that  in  spite  of  the  often  ex- 
orbitantly high  commissions  which  the  bankers  exact  for  their 
services,  the  net  result  is  more  satisfactory  than  that  secured 
through  the  railway's  own  efforts.  To  the  extent  that  this  is 
the  case,  the  bankers  are  performing  a  service  of  genuine 
economic  value,  and  it  must  be  concluded  that  under  present 
conditions  such  service  cannot  readily  be  dispensed  with. 

Assuming  this  service  as  a  necessity,  the  next  step  is  for  the 
banker  to  seek  representation  upon  the  railway  board.  His 
house  has  made  itself  responsible  for  a  large  issue  of  securities. 
It  appeals  to  the  investing  public,  not  technically  guaranteeing 
the  issue,  but  practically  doing  so  because  of  solicitude  that  its 
reputation  for  the  handling  of  high-grade  securities  shall  not 
be  impaired.  It  seeks  therefore  to  protect  its  own  standing, 
and  at  the  same  time  to  make  the  securities  more  attractive 
to  its  customers,  by  demanding  a  place  on  the  board  of  direct- 
ors from  which  it  can  follow  in  detail  the  employment  of  the 
funds  secured  through  its  assistance.  Large  investors  like 
life  insurance  companies,  savings  banks,  fire  insurance  com- 
panies, guaranty  companies,  trust  companies,  demand  as  a 
prerequisite  to  purchase  of  securities  that  the  underwriting 
house  shall  be  represented  on  the  board.  The  railway's 
credit  —  its  ability  to  sell  its  issues  —  is  dependent  frequently 
upon  the  presence  on  its  directorate  of  this  representative. 
However,  the  banker  is  not  in  the  position  solely  of  a  spec- 
tator or  a  detective.  His  expert  advice  is  sought  and  usually 
followed.  Often  he  is  in  a  position  where  he  can  stipulate 
conditions  under  which  alone  he  will  undertake  to  provide  the 
funds  required,  and  such  stipulations  are  frequently  of  im- 


BANKS  AND  THE  RAILWAYS  621 

mense  influence  in  furthering  efficient  railway  management. 
A  recent  example  is  found  in  the  furnishing  of  money  to  the 
Chesapeake  and  Ohio  Railway  Company  by  Kuhn,  Loeb  & 
Co.  under  a  stipulation  that  the  road  must  put  back  into  its 
property  each  year  a  certain  amount  of  its  earnings.  In- 
stances might  be  multiplied  in  which  railway  corporations  have 
been  saved  from  disaster  and  set  upon  their  feet  through  the 
aid  of  those  who  have  furnished  the  funds,  and  who  have 
stipulated  in  connection  therewith  that  in  order  to  insure 
their  knowledge  of  all  transactions,  and  to  give  them  a  posi- 
tion from  which  they  might  bring  their  influence  to  bear,  they 
should  be  granted  representation  on  the  railway  board. 

Of  course  it  must  be  admitted  that  the  power  of  the  banker 
may  be  misused  to  his  own  private  advantage.  The  power  is 
there  —  the  power  to  refuse  funds  —  the  power  that  comes 
from  command  of  enormous  sources  of  capital,  the  prestige 
gained  by  years  of  successful  experience.  Men  who  have  at- 
tained such  a  position  have  the  personal  qualities  that  give 
them  naturally  a  commanding  place  in  any  council  of  business 
men.  When  such  men  dominate  the  policy  of  a  railway  and 
the  results  are  disastrous,  it  is  exceedingly  difficult  fairly  to 
fix  the  responsibility  and  assess  the  blame.  The  line  between 
good  faith  and  good  judgment  or  between  personal  ambition 
that  amounts  to  breach  of  trust,  and  a  misplaced  optimism 
concerning  the  outcome  of  a  specific  policy,  is  a  very  difficult 
line  to  draw.  Although  praise  and  blame  cannot  be  assigned 
with  any  precision  between  Mr.  Morgan  and  Mr.  Mellen  in 
the  unfortunate  New  Haven  situation,  it  is  the  prevailing 
opinion  of  the  New  England  public  that  it  has  not  been  bene- 
fited greatly  by  the  presence  on  the  New  Haven  board  of  the 
distinguished  banker  member.  Generally  speaking,  however, 
the  powerful  banking  interests  have  thrown  their  influence  in 
the  direction  of  railway  efficiency  and  the  public  advantage. 
If  our  judgment  as  to  the  desirability  of  the  relationship  of 
railways  and  credit  institutions  is  to  be  determined  solely  by 
results,  we  must  conclude  that  the  balance  swings  heavily  in 
favor  of  the  continuance  of  the  present  policy. 

However,  opposition  to  the  close  association  of  financial 
houses  and  railways  has  not  sprung  from  any  such  favorable 


622  CONTROL  OF  MONEY  AND  CREDIT 

relationships  as  we  have  here  described.  It  grows  rather  out 
of  the  concentration  and  monopolization  of  credit.  A  power- 
ful banking  house  which  has  identified  its  interests  with  that 
of  one  railway  system  is  in  position,  because  of  its  direct  influ- 
ence on  the  railway  and  its  close  affiliation  with  all  other 
sources  of  credit,  seriously  to  hamper  if  not  altogether  to  pre- 
vent the  securing  of  credit  by  a  rival  interest.  This  power 
over  credit  is  not  confined  to  one  city  or  to  one  section  of  the 
country,  but  it  reaches  every  section  and  even  extends  beyond 
national  boundaries  into  the  foreign  sources  of  investment 
funds.  Local  or  small  enterprises  requiring  only  moderate 
underwriting  are  frequently  financed  independently,  but  it  is 
an  acknowledged  fact  testified  to  by  the  large  bankers  them- 
selves that  with  rare  exceptions  issues  of  securities  in  large 
amounts,  except  when  taken  up  by  the  stockholders,  must  re- 
ceive at  least  the  tacit  approval  of  the  big  financial  group. 
Participation  by  the  smaller  banking  houses  in  future  under- 
writings  depends  upon  loyalty  to  the  syndicate  in  whatever 
enterprises  are  now  being  offered.  The  little  fellows  are  in- 
clined to  respect  a  suggestion  not  to  assist  an  enterprise  of  a 
character  likely  to  interfere  with  undertakings  already  financed 
by  the  large  interests.  This  informal  but  none  the  less  ef- 
fective network  of  alliances  tends  to  destroy  the  competitive 
market  for  capital,  and  to  restrict  the  railways  to  one  source 
of  credit.  There  does  not  appear  to  be  any  serious  competi- 
tion among  the  large  bankers,  but  rather  an  understanding  in 
the  nature  of  a  division  of  the  field.  A  railway  obtains  the 
services  of  a  single  banking  house  which  acts  as  its  fiscal 
agent,  underwrites  its  securities,  receives  its  deposits,  and  has 
a  representative  on  the  railway's  board  of  directors.  When 
the  railway  becomes  involved  in  financial  difficulties,  the  same 
banking  house  organizes  protective  committees,  devises  re- 
organization schemes,  and  creates  voting  trusts.  As  Mr. 
Brandeis  has  put  it,  it  adds  to  its  duty  as  midwife  also  that  of 
undertaker. 

Is  this  relationship  potentially  dangerous  for  the  railways 
and  the  public?  The  late  Mr.  Morgan,  in  his  illuminating 
testimony  in  the  money  trust  investigation,  took  the  position 
that  the  situation  might  be  dangerous  in  the  hands  of  the 


BANKS  AND  THE  RAILWAYS  623 

wrong  men,  but  he  clearly  implied  that  there  had  been  no  bad 
results  thus  far  and  there  were  not  likely  to  be  in  the  future 
with  a  continuance  of  the  present  leadership.  His  argument 
reminds  one  of  the  young  lady  who  "  when  she  was  good  was 
very,  very  good,  and  when  she  was  bad  she  was  horrid."  Yet 
this  view  is  that  of  most  of  the  financial  leaders  who  appeared 
before  the  Pujo  committee.  .  .  . 

Mr.  Davison  and  Mr.  Schiff  both  opposed  the  policy  of  con- 
centration through  interlocking  at  the  point  where  the  repre- 
sentative of  the  two  interests  might  wield  a  dominating  influ- 
ence, but  they  found  it  difficult  to  fix  that  point. 

Mr.  Baker,  who  took  the  position  that  safety  lies  in  the  per- 
sonnel of  the  men,  that  in  good  hands  interlocking  could  not 
do  any  harm,  but  in  bad  hands  would  be  very  bad,  concluded 
nevertheless  that  the  movement  of  concentration  had  gone 
about  far  enough.  And  Mr.  George  M.  Reynolds,  of  Chi- 
cago, thus  frankly  expressed  himself:  "I  am  inclined  to 
think  that  the  concentration,  having  gone  to  the  extent  it  has, 
does  constitute  a  menace."  And  again,  "  I  think  a  more  wide 
distribution  of  the  power  of  credit  .  .  .  would  really  be  better 
in  the  long  run."  When  asked  the  direct  question,  "  Do  you 
approve  of  the  identity  of  directors  or  interlocking  directorates 
in  potentially  competing  institutions  ?  "  he  replied,  "  Personally 
I  do  not  believe  that  is  the  best  policy." 

It  should  be  kept  in  mind  that  there  is  no  evidence  on  record 
that  this  power  has  been  used  oppressively  otherwise  than  in 
the  rate  of  commission  charged.  Many  of  the  bankers  insist 
that  the  monopolization  of  credit  is  a  physical  impossibility. 
.  .  .  There  is,  nevertheless,  a  concentration  of  credit  in  com- 
paratively few  hands. 

If  the  conclusions  thus  far  established  are  sound,  it  becomes 
clear  that  the  real  evil  resulting  from  the  interlocking  of  rail- 
ways and  credit  houses,  if  any  evil  exists,  arises  primarily  out 
of  the  relation  of  credit  institutions  to  each  other,  rather  than 
out  of  their  relation  to  the  railways  through  representation  on 
railway  boards.  Were  this  interlocking  of  railways  and  banks 
to  be  wholly  prohibited  without  any  alteration  in  the  organiza- 
tion of  the  credit  market,  I  am  unable  to  see  how  the  situation 
would  be  changed  materially.  The  tendency  on  the  part  of 


624  CONTROL  OF  MONEY  AND  CREDIT 

the  bankers  would  still  be  to  follow  the  law  of  "  banking 
ethics  "  and  divide  the  field ;  a  railway  would  still  employ  a 
single  banking  house  as  its  fiscal  agent,  and  this  banking  house 
would  still  exercise  a  powerful  influence  in  determining  the 
policy  of  the  railway.  At  the  same  time  the  railway  would  be 
deprived  of  the  presence  on  its  board  of  a  financial  expert 
whose  experience  might  be  drawn  upon  in  the  detail  of  man- 
agement day  by  day. 

As  Mr.  Reynolds  has  admitted,  the  menace  is  in  the  con- 
centration of  credit.  Such  power  may  not  thus  far  have  been 
misused.  But  as  the  Pujo  committee  has  said,  "  whenever 
the  incentive  is  at  hand,  the  machinery  is  ready."  Those 
who  have  the  public  welfare  at  heart  have  no  right  to  assume 
that  such  power  will  never  be  used  to  the  personal  interest  of 
the  bankers  themselves  and  to  the  injury  of  the  public.  While 
I  have  no  great  enthusiasm  for  the  popular  pastime  of  rushing 
to  Washington  for  a  statute  whenever  the  economic  machinery 
fails  to  run  smoothly,  I  am  in  sympathy  with  those  who  are 
studying  the  problem  of  the  restoration  of  an  open  competitive 
market  for  capital. 

However,  this  is  a  problem  of  extraordinary  difficulty,  and 
I  do  not  myself  see  the  way  at  present  to  its  solution.  I  am 
aware  that  Congress  has  enacted  legislation  with  the  purpose 
of  destroying  this  concentration  of  credit,  and  that  many  look 
upon  the  Clayton  Act,  so  far  as  it  touches  our  problem,  as  a 
distinct  step  in  advance.  Personally  I  am  sceptical  as  to  its 
efficacy  in  its  present  form.  The  opportunities  for  evasion 
are  too  numerous.  However,  it  can  be  laid  down  as  a  general 
rule  that  all  statutory  enactment  which  really  endures  is  a 
product  of  successive  increments  of  legislation  —  the  result 
of  experimental  tests  and  the  knowledge  that  is  gained  by  ex- 
perience. It  is  no  argument  against  the  interlocking  pro- 
visions of  the  Clayton  Act  that  they  do  not  solve  the  problem 
and  that  they  can  be  evaded  readily.  Such  an  attitude  of 
timidity  and  pessimism  assumed  twenty-five  years  ago  would 
never  have  given  us  our  present  air-tight  Interstate  Commerce 
Act.  It  may  well  be,  however,  that  no  relief  can  be  found 
short  of  the  radical  step  of  employing  government  credit  in 
aid  of  public-service  industries.  So  vital  is  the  necessity  of 


BANKS  AND  THE  RAILWAYS  625 

the  service  to  the  people  that  the  time  may  come  when  govern- 
ment loans  to  transportation  corporations  will  appear  to  be  a 
logical  and  natural  step.  But  this  is  a  digression. 

Once  this  free  market  for  capital  is  assured,  the  question 
again  arises,  Shall  the  railway  board  of  directors  contain 
banker  members?  Obviously  the  only  purpose  that  the  rail- 
way could  then  have  in  admitting  bankers  to  its  directorate 
would  be  the  opportunity  to  utilize  their  experience  in  the 
direct  management  of  the  property.  Quite  as  obviously  the 
principal  motive  of  the  banker  in  accepting  membership  on  a 
railway  board  would  be  to  represent  the  underwriters  and  to 
act  as  fiscal  agent.  But  with  the  capital  market  competitive, 
I  can  find  no  serious  objection  to  such  relationship.  Even 
under  present  conditions  the  banker  in  the  majority  of  cases 
respects  his  trust,  refuses  to  vote  on  questions  involving  his 
personal  interest,  and  performs  loyally  his  service  to  the  rail- 
way; but  his  mere  presence  on  the  board  as  the  embodiment 
of  the  railway's  only  source  of  credit  may  be  sufficient  to 
control  the  situation  in  his  behoof.  However,  with  a  free 
credit  market,  the  dominating  position  of  the  banker  largely 
disappears  and  he  becomes  what  he  ought  to  be,  an  expert 
adviser  on  financial  matters.  It  may  be  asked  why,  if  the 
banker  is  now  to  confine  his  activities  to  what  Mr.  Loree  has 
called  the  "  necessarily  intimate  relation  between  the  banker 
and  the  seeker  for  accommodation,"  this  cannot  be  accom- 
plished in  the  same  manner  as  in  unincorporated  businesses 
without  putting  the  banker  on  the  directorate.  In  reply  at- 
tention may  be  called  to  the  fact  that  even  in  the  case  of 
unincorporated  businesses,  the  credit  departments  of  the  large 
banks  are  virtually  in  the  position  of  directors,  so  intimate 
and  comprehensive  is  their  influence  and  advice.  But  more 
than  this  the  business  of  a  railroad  is  so  complex  and  ex- 
tensive, its  activities  are  so  multifarious,  that  an  intimacy  with 
its  affairs  sufficient  to  make  the  banker's  counsel  of  value 
would  be  impossible  except  by  actual  presence  on  the  direc- 
torate. 

Under  these  changed  conditions  of  credit,  I  can  see  greater 
opportunity  for  the  utilization  of  the  service  of  expert  bankers 
in  railway  management.  Directorships  which  have  been 


626  CONTROL  OF  MONEY  AND  CREDIT 

monopolized  in  the  hands  of  a  few  banker  specialists  in  railway 
securities  should  then  be  more  widely  distributed.  It  is  quite 
impossible  to  believe  that  expert  banking  talent  available  for 
this  service  is  as  rare  as  the  present  situation  would  suggest, 
in  which  the  abilities  of  a  relatively  few  men  are  made  to  do 
duty  in  dozens  of  corporations.  This  absurd  situation  springs 
not  from  a  scarcity  of  talent  but  from  the  narrow  market  for 
credit.  A  liberation  of  that  market  would  bring  latent  ability 
from  its  hiding-places,  and  by  the  infusion  of  new  blood  would 
stimulate  the  management  of  our  railway  enterprises.  It 
would  open  this  field  of  activity  to  men  "  who  have  been 
obliged  to  serve  when  their  abilities  entitled  them  to  direct." 


CHAPTER  XXIX 

CRISES 
THE  NATURE  OF  AN  ECONOMIC  CRISIS 

1  A  definition  of  an  economic  "  crisis  "  is,  like  most  other 
definitions,  very  difficult  to  construct.  By  way  of  introduc- 
tion we  shall  quote  a  few  chosen  somewhat  at  random. 
Adolph  Wagner,  the  German  economist,  expresses  his  idea 
by  saying :  "  Crises  imply  .  .  .  the  overwhelming  and  simul- 
taneous occurrence  of  inability  on  the  part  of  independent 
entrepreneurs  to  pay  their  debts."  This  is  similar  to  the 
statement  of  John  Stuart  Mill:  "  There  is  said  to  be  a  com- 
mercial crisis  when  a  great  number  of  merchants  and  traders 
at  once  either  have,  or  apprehend  that  they  shall  have,  a  diffi- 
culty in  meeting  their  engagements."  Professor  E.  D.  Jones 
says :  "  A  crisis  is  the  sudden  application  of  a  critical  con- 
servatism to  business  transactions,  leading  to  such  a  demand 
for  liquidation  as  to  cause  a  widespread  inability  among  busi- 
ness men  to  meet  their  obligations."  Senator  Theodore  E. 
Burton  states :  "  The  word  crisis,  if  employed  with  entire 
accuracy,  describes  a  period  of  acute  disturbance  in  the  busi- 
ness world,  the  prevailing  features  of  which  are  the  break- 
down of  credit  and  prices  and  the  destruction  of  confidence. 
It  has  especially  to  do  with  the  relations  of  debtor  and 
creditor." 

None  of  these  definitions  gives  so  clear  an  idea  as  does  a 
brief  description.  Probably  no  one  has  ever  pictured  the 
crisis  and  the  associated  events  more  effectively  than  did 
Frederick  Engels  in  his  little  volume,  Socialism:  Utopian  and 
Scientific: 

As  a  matter  of  fact,  since  1825,  when  the  first  general  crisis 
broke  out,  the  whole  industrial  and  commercial  world,  production 

i  E  M  Patterson,  The  Theories  Advanced  in  Explanation  of  Economic 
Crises.  Annals  of  American  Academy  of  Political  and  Social  Science, 

Vol.  59,  May,  1915,  PP-  133-6- 

627 


628  CRISES 

and  exchange  among  all  civilized  peoples  and  their  more  or  less 
barbaric  hangers-on,  are  thrown  out  of  joint  about  once  every  ten 
years.  Commerce  is  at  a  standstill,  the  markets  are  glutted,  products 
accumulate,  as  multitudinous  as  they  are  unsaleable,  hard  cash  dis- 
appears, credit  vanishes,  factories  are  closed,  the  mass  of  the  work- 
ers are  in  want  of  the  means  of  subsistence;  bankruptcy  follows 
upon  bankruptcy,  execution  upon  execution.  The  stagnation  lasts 
for  years;  productive  forces  and  products  are  wasted  and  de- 
stroyed wholesale,  until  the  accumulated  mass  of  commodities  finally 
filter  off,  more  or  less  depreciated  in  value,  until  production  and 
exchange  gradually  begin  to  move  again.  Little  by  little  the  pace 
quickens.  It  becomes  a  trot.  The  industrial  trot  breaks  into  a 
canter,  the  canter  in  turn  grows  into  the  headlong  gallop  of  a 
perfect  steeplechase  of  industry,  commercial  credit,  and  speculation, 
which  finally,  after  breakneck  leaps,  ends  where  it  began  —  in  the 
ditch  of  a  crisis.  And  so  over  and  over  again. 

Perhaps  even  this  vivid  word  picture  will  be  less  impressive 
to  some  than  a  few  facts  as  to  the  serious  effects  of  the  crisis 
and  the  depression  that  follows  it.  Professor  Wesley  C. 
Mitchell  in  his  recent  volume  entitled  Business  Cycles  has 
recorded  the  significant  features  of  the  crisis  of  1907  in  Eng- 
land and  the  United  States  and  the  following  points  have  been 
taken  from  his  account.  By  the  middle  of  the  summer  evi- 
dences of  difficulty  had  begun  to  appear  in  England.  British 
railway  stocks  had  fallen  off  in  price;  the  shipbuilding  yards 
had  few  new  contracts;  costs  of  production  had  become  so 
great  that  many  manufacturers  were  refusing  to  take  new 
business  at  the  ruling  quotations;  the  building  trades  were 
dull;  the  ratio  of  net  to  gross  railway  receipts  declined;  com- 
modity prices  began  to  drop ;  bank  clearings  fell  off ;  imports 
gained  less  rapidly;  and  the  percentage  of  trade  union  mem- 
bers unemployed  rose  from  2.8  per  cent,  at  the  end  of  April 
to  3.6  per  cent,  by  the  close  of  August.  These  difficulties 
came  to  a  climax  in  the  latter  half  of  the  year,  being  intensified 
by  the  crash  in  the  United  States.  The  bank  rate  of  the  Bank 
of  England  rose  from  4^2  to  7  per  cent.,  where  it  remained 
for  nearly  two  months.  During  this  period  the  market  rate 
averaged  from  5^2  to  6]/2  per  cent.  Imports  and  exports 
showed  smaller  and  smaller  increases  over  the  preceding  year 
and  in  the  early  months  of  1908  began  to  decline;  clearings 


NATURE  OF  CRISES  629 

fell  off  sharply  and  trade  union  unemployment  increased  to 
nearly  10  per  cent,  during  the  latter  months  of  1908. 

In  the  United  States,  where  the  crisis  degenerated  into  a 
panic,  conditions  were  much  worse.  In  advance  of  the  actual 
outbreak  of  the  panic  there  was  for  months  evidence  of  a 
tension  in  the  investment  market.  Copper  especially  fell  in 
price  and  was  followed  by  copper  stocks.  This  precipitated 
difficulty  among  a  group  of  banks  that  were  more  or  less 
closely  identified  with  the  copper  interests.  Runs  were 
started  and  a  number  of  banks  were  forced  to  suspend  pay- 
ments. A  scramble  for  cash  followed,  spreading  from  New 
York  throughout  the  United  States  and  accompanied  by  very 
serious  consequences.  Among  the  worst  of  the  effects  were 
a  premium  on  currency  which  rose  at  one  time  as  high  as  4 
per  cent. ;  the  necessity  of  introducing  numerous  substitutes 
for  cash;  a  demoralization  of  the  domestic  and  foreign  ex- 
change markets  that  caused  heavy  losses  both  to  bankers  and 
to  business  men,  \vhile  the  amount  and  the  prices  of  securities 
dealt  in  on  the  stock  exchanges  seriously  declined.  During 
November  and  December  currency  was  at  a  premium  of  from 
y%  to  4  per  cent.  Call  loan  rates  were  erratic,  going  as  high 
as  125  per  cent,  in  the  latter  part  of  October  and  fluctuating 
between  5  and  25  per  cent,  as  late  as  during  the  latter  half 
of  December.  During  November  there  was  a  decline  in  the 
amount  of  time  loans  and  the  quoted  rates  ranged  from  6  to 

7  per  cent,  in  October,  12  to  16  per  cent,  in  November,  and 

8  to  12  per  cent,  in  December.     Worse  still  was  the  stoppage 
of  business  by  those  enterprises  that  could  not  pay  the  high 
rates  and  could  make  no  special  arrangements  to  secure  lower 
ones.     Business  failures  in  the  United  States  which  had  been 
as  low  as  161  in  the  last  week  of  1906,  were  300  for  the  week 
ending  December   19,   1907,  and  435   for  the  week  ending 
January  9,  1908.     In  the  second  quarter  of  1907  there  were 
2,471  and  for  the  first  quarter  of  1908  there  were  4,909. 

These  derangements  of  business  would  seem  to  be  of  in- 
terest primarily  to  the  bankers  and  brokers  or  to  the  large 
borrowers  —  to  the  capitalist  class.  The  counterpart  of  the 
picture  is  to  be  found  in  the  effect  of  the  crisis  upon  the  man 


630  CRISES 

of  small  means  and  upon  the  poor.  Inability  to  borrow  may 
mean  considerable  inconvenience  or  even  financial  ruin  for 
the  man  of  large  affairs  but  it  does  not  usually  mean  actual 
suffering.  Nevertheless  his  failure  to  secure  funds  and  the 
necessity  of  selling  his  securities  or  commodities  at  a  low 
price  may  force  him  to  close  his  factory,  to  delay  extensions, 
or  at  least  to  curtail  operations.  He  receives  fewer  orders  for 
goods  and  as  a  result  buys  smaller  amounts  of  raw  materials 
and  lessens  his  own  output. 

This  means  reductions  of  wages  and  discharge  of  work- 
men. Some  writers  have  urged  that  the  workingman  receives 
a  fixed  wage  and  does  not  assume  industrial  risks,  which  are 
borne  by  the  capitalist  or  entrepreneur.  Such  a  statement  is 
fallacious.  The  employee  participates  in  the  risks  of  modern 
industry  and  suffers  from  a  business  derangement  far  more 
severely  than  his  employer.  The  capitalist  secures  less  profits 
but  with  his  accumulated  savings  ordinarily  endures  no  real 
privation,  while  large  numbers  of  the  workers  with  little  or 
no  savings  face  actual  hunger  or  starvaton.  Demands  upon 
charitable  organizations  increase,  bread  lines  grow  longer,  and 
suffering  becomes  widespread  and  intense  until  the  crisis  and 
the  ensuing  depression  are  over.  '.  .  . 

THE  CRISIS  OF  1907  IN  THE  LIGHT  OF  HISTORY 

1.  .  .  From  one  point  of  view  .  .  .  every  economic  crisis 
is  a  financial  crisis.  For  since  values  are  expressed  in  terms 
of  money,  and  since  the  modern  business  superstructure  is 
erected  on  the  basis  of  credit,  every  economic  revulsion  ex- 
presses itself  through  the  medium  of  a  change  in  prices;  and 
since  the  bank  is  the  center  of  credit  operations,  every  crisis 
inevitably  involves  a  revolution  in  the  conditions  of  credit. 
From  this  point  of  view,  all  crises  may  be  declared  to  be 
financial  crises. 

From  another  standpoint,  however,  a  distinction  may  be 
drawn  between  financial  crises  proper  and  commercial  or  in- 

1  Address  by  Edwin  R.  A.  Seligman,  The  Crisis  of  1907  in  the  Light 
of  History,  in  The  Currency  Problem  and  the  Present  Financial  Situa- 
tion, A  Series  of  Addresses  Delivered  at  Columbia  University,  1907-1908, 
ix-xxv.  The  Columbia  University  Press,  1908. 


CRISIS  OF  1907  63! 

dustrial  crises  in  the  larger  sense.  There  may  be  a  financial 
panic  or  crisis  due  primarily  to  temporary  and  sudden  oscilla- 
tions in  the  condition  of  the  money  market  or  in  the  price  of 
securities.  Such  oscillations,  sharp  and  sudden  though  they 
be,  may  have  but  little  relation,  whether  of  effect  or  of  cause, 
to  the  general  commercial  and  industrial  interests.  Of  this 
character,  for  instance,  were  the  original  Black  Friday  in 
England,  in  1745,  its  namesake,  the  famous  Black  Friday  in 
1869  in  New  York,  as  well  as  many  spasmodic  fluctuations 
due  either  to  political  rumors  like  that  which  followed  the 
Venezuelan  Message  of  1895,  or  to  temporary  speculative 
manipulations,  like  the  Northern  Pacific  "squeeze"  of  1901. 
Of  a  distinctly  different  nature  are  those  wider  disturbances 
which  are  traceable  to  more  general  economic  causes  and 
which,  even  though  they  culminate  in  acute  financial  trouble, 
are  followed  by  an  industrial  and  commercial  depression  of 
more  or  less  magnitude. 

Into  which  category  is  to  be  put  the  crisis  of  1907;  and 
if  in  the  latter,  what  were  its  causes? 

At  the  outset  it  must  be  remembered  that  crises  are  essen- 
tially modern  phenomena.  We  have  had  financial  transac- 
tions, and  that,  too,  on  a  large  scale,  for  many  centuries  and  in 
many  civilizations.  But  crises,  in  contradistinction  to  tem- 
porary panics,  have  existed  in  England  only  since  the  middle 
of  the  eighteenth,  and  in  other  countries  only  since  the  be- 
ginning of  the  nineteenth,  century.  The  first  crisis  in  Eng- 
land, barring  the  financial  flurry  connected  with  the  South  Sea 
Scheme  in  1720,  was  that  of  1763,  followed  by  the  minor  dis- 
turbances of  1772  and  1783,  and  the  more  widespread  con- 
vulsions of  1793,  1810,  and  1825.  The  first  crisis  in  the 
United  States  was  that  of  1817;  and  it  was  not  until  1837 
that  we  find  the  first  international  crisis,  spreading  from  the 
United  States  to  England  and  then  to  France.  In  Germany 
the  period  of  important  crises  was  ushered  in  even  later. 

Crises,  in  other  words,  are  products  of  modern  economic 
life.  Modern  economic  life,  however,  has  as  its  basal  charac- 
teristic industrial  capitalism,  with  the  factory  system  and  the 
newer  methods  of  production  for  a  wide  market.  This 
transition  to  modern  industrial  capitalism  began  in  England 


632  CRISES 

in  the  latter  half  of  the  eighteenth  century,  was  initiated  in 
America  in  the  first  two  decades  of  the  nineteenth  century, 
and  took  place  on  the  continent  at  a  later  date,  last  of  all  in 
Germany.  The  explanation  of  crises  must  therefore  be 
sought  in  some  feature  of  our  modern  capitalistic  life. 

The  current  explanations  may  be  divided  into  two  cate- 
gories. Of  these  the  first  includes  what  might  be  termed  the 
superficial  theories.  Thus  it  is  commonly  stated  that  the  out- 
break of  a  crisis  is  due  to  lack  of  confidence  —  as  if  the  lack 
of  confidence  was  not  in  itself  the  very  thing  which  needs  to 
be  explained.  Of  still  slighter  value  is  the  attempt  to  asso- 
ciate a  crisis  with  some  particular  governmental  policy,  or 
with  some  action  of  a  country's  executive.  Such  puerile  in- 
terpretations have  commonly  been  confined  to  countries  like 
the  United  States,  where  the  political  passions  o'f  a  democracy 
have  had  the  fullest  sway.  Thus  the  crisis  of  1893  was  as- 
cribed by  the  Republicans  to  the  impending  Democratic  tariff 
of  1894;  and  the  crisis  of  1907  has  by  some  been  termed  the 
"  Roosevelt  panic,"  utterly  oblivious  of  the  fact  that  from 
the  time  of  President  Jackson,  who  was  held  responsible  for 
the  troubles  of  1837,  every  successive  crisis  has  had  its  presi- 
dential scapegoat,  and  has  been  followed  by  a  political  re- 
vulsion. The  crisis  of  1857  helped  to  weaken  the  Democrats ; 
the  crisis  of  1873  resulted  in  a  popular  majority  for  Tilden; 
the  crisis  of  1884  put  Cleveland  into  the  presidential  chair; 
and  the  crisis  of  1893,  with  the  ensuing  depression,  brought 
the  Republicans  back  to  power. 

Opposed  to  these  popular,  but  wholly  unfounded,  interpreta- 
tions is  the  second  class  of  explanations,  which  seek  to  burrow 
beneath  the  surface  and  to  discover  the  more  occult  and 
fundamental  causes  of  the  periodicity  of  crises.  Here  we 
find  an  interesting  and  progressive  series  of  attempts  to 
grapple  with  the  difficulties  of  the  problem.  For  a  long  time 
economists  and  business  men  advanced  the  theory  of  over- 
production, forgetful  of  the  fact  that  there  really  cannot  be 
any  such  phenomenon  as  too  much  actual  production  of 
wealth. 

With  the  disappearance  of  this  doctrine  there  came  into 
prominence  its  variant,  which  put  the  emphasis  on  relative, 


CRISIS  OF  1907  633 

rather  than  absolute,  or  universal  overproduction,  that  is,  the 
overproduction  of  some  things  and  the  underproduction  of 
others.  This  theory  also  failed  to  command  general  assent, 
for  the  reason  that  no  one  could  show  in  what  respects  there 
was  any  underproduction  of  wealth,  or  any  lack  of  particular 
products  during  the  years  preceding  a  crisis.  Others  again, 
have  sought  the  causal  fact  in  underconsumption,  alleging 
that  the  larger  consumption  of  wealth  will  in  itself  take  up 
all  the  slack  of  production,  and  thus  obviate  a  crisis.  This 
explanation  also  is  inadequate,  because  it  overlooks  the  fact 
that  the  real  falling  off  in  consumption  comes  after  the  crisis 
has  developed  and  not  before;  in  fact,  the  period  of  prosperity 
which  precedes  a  crisis  is  generally  marked  by  a  prodigious 
increase  in  consumption. 

The  socialists,  again,  seek  to  explain  crises  by  the  existence 
of  private  property  in  the  means  of  production,  and  contend 
that  if  we  were  to  cease  the  exploitation  of  the  laborer  by 
the  modern  capitalistic  method,  crises  would  disappear. 
While,  however,  agreeing  in  this  general  conclusion,  they 
differ  in  their  detailed  analyses.  Thus  Rodbertus  maintains 
that  the  secret  of  crises  is  to  be  found  in  the  fact  that  the 
progress  of  industry  causes  a  continually  greater  output  of 
product,  while  the  exclusion  of  the  laboring  classes  from  any 
participation  in  this  increased  productivity  involves  a  relative 
diminution  in  demand,  and  thus  ultimately  a  fall  in  price, 
culminating  in  a  crisis.  Marx,  on  the  other  hand,  puts  the 
emphasis  on  the  fact  that  the  necessary  fall  in  the  rate  of 
profits  (which,  according  to  him,  is  a  result  of  the  surplus 
value,  or  exploitation  theory)  is  incompatible  with  the  greatly 
increased  productivity  of  fixed  capital  inherent  in  the  present 
system,  and  that  the  clashing  of  these  two  incongruous  ten- 
dencies of  modern  industrial  life  brings  about  a  relative  over- 
production of  capital,  and  gives  rise  to  periodical  explosions. 
This  view,  finally,  is  sharply  criticised  by  the  latest  and  ablest 
of  the  socialist  theorists,  Tngan-Baranowsky,  who  in  turn 
maintains  that  crises  are  due  primarily  to  the  fact  that  under 
the  modern  system  it  is  impossible  to  invest  the  fresh  ac- 
cumulations of  capital  proportionally  in  all  branches  of  in- 
dustry, and  that  it  is  this  relative  disproportion  of  accumulated 


634  CRISES 

capital  to  the  particular  demand  that  causes  the  anarchy  of 
the  market  and  the  recurrent  convulsions  of  industry. 

While  the  socialist  scholars  have  undoubtedly  made  valuable 
contributions  to  the  discussion  of  the  problem,  they,  like  the 
earlier  economists,  have  erred  in  laying  stress  on  the  question 
of  technical  production  rather  than,  as  is  done  by  the  more 
recent  economic  thinkers,  on  that  of  business  enterprise  and 
capitalization.  This  is  manifestly  not  the  place  to  elaborate 
a  general  theory  of  crises.  If  we  attempt,  however,  to  give 
the  bare  outline  of  the  modern  explanation,  it  would  be  ap- 
proximately as  follows : 

The  problem  of  crises  or  industrial  depressions  is  one  of 
relative  capitalization.  Under  the  present  system  of  enter- 
prise, production  is  carried  on  in  mass  for  a  prospective 
market,  rather  than  as  formerly  in  small  quantities  to  fill  a 
definite  order.  Even  if  it  be  contended  that  certain  factories 
nowadays  are  busy  with  producing  to  order,  it  is  none  the  less 
true  that  numerous  plants  are  continually  being  erected  in  the 
expectation  that  orders  will  be  received  in  the  future.  The 
good  times,  or  periods  of  rising  prices,  may  be  due  to  many 
causes  —  either  in  general  to  an  augmented  gold  output,  or  in 
particular  to  the  increase  in  the  demand  for  some  special 
product,  whether  in  the  iron  industry  through  a  new  navy 
program,  or  in  the  clothing  industry  through  the  outbreak  of 
a  war,  or  in  any  other  industry  through  a  change  of  fashion 
or  what  not.  Prices  first  rise  in  the  particular  enterprise, 
production  augments,  the  movement  spreads  to  other  lines 
of  business,  and  the  new  enterprises  are  financed  by  loans 
from  the  banks  or  trust  companies,  or  by  the  sale  of  securities 
on  a  capitalization  proportionate  to  the  anticipated  earnings. 
In  times  of  buoyancy  we  are  continually  capitalizing  anticipated 
earnings  and  future  hopes,  and  we  do  this  through  the  utiliza- 
tion of  credit  on  a  large  scale.  We  build  railways,  put 
millions  into  steel  plants,  "  boom  "  land  sites,  and  form  com- 
binations of  all  kinds,  employing  the  credit  facilities  granted 
by  the  banks,  or  throwing  the  securities  on  the  stock  market. 
We  "water"  the  stock  or,  if  that  be  forbidden  by  law,  we 
drive  the  market  quotations  to  a  high  point,  because  we  think 
that  this  is  warranted  by  prospective  earnings.  Sometimes  we 


CRISIS  OF  1907  635 

say  that  we  capitalize  the  good  will  or,  in  the  case  of  quasi- 
public  enterprises,  the  franchise ;  but  in  all  cases  we  capitalize 
the  future  because  we  believe  that  we  shall  earn  an  income 
which  will  justify  this  capitalization. 

The  peculiarity,  however,  of  an  up-grade  movement  which 
rests  on  modern  credit  facilities  is  that  we  wear  magnifying 
glasses  or  look  at  the  future  in  too  roseate  a  light.  It  is  a 
natural  tendency  of  human  nature  to  capitalize  one's  hopes 
and  expectations  too  liberally.  If  this  is  done  on  a  continu- 
ally larger  scale,  the  capitalization  becomes  so  great  that  actual 
earnings  do  not  come  up  to  our  anticipations  or  the  fear  of  a 
discrepancy  between  actual  and  estimated  earnings  begins  to 
obsess  us.  It  becomes  necessary  to  reduce  the  capitalization 
to  its  true  dimensions,  i.  e.,  to  a  sum  proportioned  to  actual 
earnings.  This  process  of  readjustment  of  overcapitalized 
values  obviously  involves  loss;  but  readjustment  there  must  be. 
If  the  realization  of  its  necessity  is  sudden,  we  have  a  crisis 
or  panic. 

In  the  height  of  the  period  of  exaltation  or  prosperity, 
something  happens  to  disturb  confidence.  A  chance  occur- 
rence, a  mere  rumor,  may  suffice.  Some  bank  considers  its 
credit  too  heavily  engaged,  or  suspects  the  adequacy  of  the 
collateral.  Just  at  the  flood  of  the  tide,  when  new  demands 
are  constantly  being  made,  it  finds  itself  unable  or  unwilling 
to  respond.  Its  refusal  starts  or  intensifies  the  feeling  of 
insecurity,  and  with  the  inability  of  some  important  concern 
to  meet  its  obligations,  a  failure  occurs  and  the  crisis  is  pre- 
cipitated. If,  on  the  other  hand,  the  situation  is  well 
handled,  and  if  the  readjustment  of  the  overcapitalized  values 
to  actual  earning  capacity  can  be  brought  about  more  gradu- 
ally, we  have,  in  lieu  of  a  crisis,  a  liquidation  and  a  period 
of  depression  which  lasts  until  the  up-grade  movement  again 
sets  in. 

Crises,  therefore,  are  not  necessarily  the  result  of  in- 
creased technical  production.  The  important  point  is  not  pro- 
duction, but  capitalization.  There  may  be  overcapitaliza- 
tion, without  overproduction.  Overproduction  of  particular 
things  may  indeed  accompany  overcapitalization,  but  the  stress 
must  be  laid,  not  on  the  relation  between  production  and  con- 


636  CRISES 

sumption,  as  the  old  writers  assumed,  but  on  the  discrepancy 
between  the  investment  and  its  returns. 

While  the  general  features  of  a  crisis  are  thus  everywhere 
the  same,  the  details  differ  in  each  case.  Sometimes  it  is  the 
banks  that  fail  first,  sometimes  the  general  business  enter- 
prises. Sometimes  it  is  the  railway  securities  that  first  feel 
the  strain,  at  other  times  "  the  industrials,"  and  at  still  other 
times  the  raw  materials.  Sometimes  the  bolt  comes  out  of 
the  clear  sky  with  prices  at  a  maximum,  sometimes  it  is  only 
the  last  stage  of  a  period  of  liquidation  with  progressively 
lower  prices.  But  however  unpredictable  and  seemingly  in- 
scrutable the  actual  course  of  events,  the  fundamental  ex- 
planation is  always  the  necessary  readjustment  of  capitaliza- 
tion to  actual  earning  capacity. 

That  this  is  true  of  all  our  crises  can  be  seen,  from  a  hasty 
review.  The  crisis  of  1817  was  the  result  of  the  first  utiliza- 
tion of  modern  capitalist  methods  in  America.  The  period 
of  the  War  of  1812  was  marked  by  three  facts:  first,  the  in- 
dustrial revolution  in  New  England  and  the  introduction  of 
the  factory  system  in  the  textile  industry;  second,  the  great 
development  of  internal  improvements  through  canal  and  turn- 
pike companies;  third,  the  sudden  multiplication  of  banks  to 
finance  the  new  enterprises.  The  consequence  was  the  so-» 
called  "  Golden  Age,"  which  lasted  for  several  years,  until 
checked  by  the  immense  imports  from  England  after  the  war, 
and  destroyed  by  the  collapse  of  the  overcapitalized  under- 
takings. It  was  well  into  the  twe'nties  before  the  country  re- 
covered from  the  industrial  depression,  and  then  came  the 
second  up-grade  movement,  which  culminated  in  1837.  This 
was  primarily  a  land  and  transportation,  rather  than  a  purely 
industrial,  phenomenon.  The  canals  and  turnpikes  in  the  East 
were  now  being  replaced  by  railways,  and  the  spread  of  slavery 
caused  a  rush  of  cotton  planters,  not  only  to  the  black  belt,  but 
to  the  pine  barrens  and  hill  country  of  the  South.  It  was 
primarily  land  values  that  were  being  overcapitalized,  and  the 
process  went  on  to  such  an  extent  that  the  annual  land  reve- 
nues of  the  Government  now  exceeded  the  total  governmental 
receipts  from  all  sources  of  a  few  years  before.  Finally,  to 
finance  this  land  movement  there  were  called  into  being  hun- 


CRISIS  OF  1907  637 

dreds  of  the  "  coon-box  "  banks,  that  found  a  champion  in 
President  Jackson  in  his  war  against  the  Bank  of  the  United 
States.  As  the  period  of  exaltation  had  been  unexampled,  so 
the  collapse  was  proportionally  great.  The  crisis  of  1837, 
followed  as  it  was  by  those  of  1839  and  1841,  was  still  more 
serious  than  that  of  1817. 

It  was  again  well-nigh  a  decade  before  the  readjustment  of 
values  had  been  completed.  The  following  decade  was  in 
turn  marked  by  five  striking  facts:  first,  the  gold  discoveries 
of  California  and  Australia,  which  soon  initiated  a  general 
rise  of  prices;  second,  the  consummation  of  the  revolution  in 
the  media  of  transportation  by  land  and  water,  and  the  settle- 
ment of  the  entire  Mississippi  Valley,  the  most  fertile  portion 
of  the  continent ;  third,  the  abolition  of  the  corn  laws  in  Eng- 
land and  the  opening  up  of  a  market  for  our  incipient  surplus 
of  wheat;  fourth,  the  era  of  industrial  invention  which  re- 
sulted in  the  application  of  capitalistic  methods  to  new  classes 
of  enterprise  besides  the  old  textile  industries;  and  fifth,  the 
development  of  free  banking  with  the  "  wildcat  "  institutions 
to  provide  the  credit  facilities  for  this  prodigious  over- 
capitalization. The  crisis  of  1857,  which  was  the  inevitable 
result,  was  perhaps  still  more  acute  than  its  predecessors. 
The  continuance  of  its  depressing  influence  on  industry,  how- 
ever, was  checked  by  the  economic  effects  of  the  Civil  "War, 
which  gave  an  artificial  stimulus  to  many  forms  of  enterprise. 

In  the  period  immediately  succeeding  the  war,  great  changes 
again  occurred.  The  transcontinental  roads  were  completed 
and  the  Eastern  trunk  lines  consolidated;  the  great  wheat 
fields  of  the  country  were  opened  up  under  the  new  home- 
stead laws,  and  the  period  of  large  exports  began;  the  Bes- 
semer process  revolutionized  the  iron  industry,  and  the  factory 
system  was  now  applied  to  boots,  sewing-machines,  and  agri- 
cultural implements ;  the  great  copper  and  silver  deposits  were 
developed,  and  the  petroleum  output  grew  apace;  while  the 
greenbacks  and  the  greenback  movement  fomented  the  process 
of  inflation.  The  discrepancy  between  the  capitalization  and 
the  actual  earning  capacity  of  the  country's  business  enter- 
prises again  became  so  overwhelming  that  the  necessary  read- 
justment took  the  form  of  the  convulsion  of  1873  —  a  con- 


638  CRISES 

vulsion  the  depressing  effects  of  which  were  felt  with  almost 
increasing  severity  for  six  years. 

The  crises  of  1884  and  1893  were  both  less  intensive  and 
more  short-lived  than  their  predecessors,  for  reasons  which 
it  is  now  not  difficult  to  explain.  The  resumption  of  specie 
payment  in  1879  was  rendered  possible,  and  was  followed  by 
a  series  of  abundant  crops  which  revivified  enterprise,  and 
which  were  aided  by  the  use  of  agricultural  machinery  on  a 
large  scale.  The  energy  and  the  capital  of  the  nation,  how- 
ever, were  devoted  in  increasing  measure  to  the  transporta- 
tion industry.  This  resulted  in  a  perfect  orgy  of  new  rail- 
road construction,  the  entire  mileage  of  the  country  increasing 
in  five  years  by  50  per  cent.  As  the  overcapitalization  was 
primarily  a  railway  overcapitalization,  the  resulting  reaction 
of  1884  was  essentially  a  railway  crisis,  leading  to  but  indirect 
and  temporary  disturbances  in  industry  at  large.  Within  a 
year  or  two  recovery  was  general,  and  the  prosperous  years 
from  1886  onward  were  reflected  in  the  existence  of  a  huge 
surplus  of  governmental  revenues.  The  live-stock  and  meat- 
packing business  attained  its  high-water  mark;  the  textile 
industries  made  great  progress  in  the  finer  grades,  and  the 
ready-made  clothing  industry  assumed  vast  dimensions;  the 
iron  and  steel  industry  was  revolutionized  anew  by  the  inven- 
tion of  the  open-hearth  process  and  the  utilization  of  cheap 
ore  from  the  Lake  Superior  region;  the  South  was  being 
quickly  developed  by  the  Northern  capital  that  poured  into 
the  cotton  mills  and  the  coal  and  iron  mines;  electricity  was 
applied  to  industry  on  an  increasing  scale,  and  the  country 
took  rapid  strides  in  its  evolution  from  an  agricultural  to  an 
industrial  community. 

The  movement  of  overcapitalization,  however,  was  some- 
what checked  by  two  important  facts :  the  downward  tilt  of 
world  prices  in  general,  which  had  been  falling  since  1873 
and  which  were  fast  reaching  their  lowest  point;  and  the 
relative  shrinkage,  not  only  in  the  amount  of  the  wheat  crop, 
but  also  in  the  value  of  both  the  wheat  and  the  cotton  crops. 
The  resulting  reaction  of  1893,  which  was  itself  partly  due 
to  the  ill-timed  experiments  with  silver  legislation,  was  as  a 
consequence  neither  so  profound  nor  so  long-continued,  since 


CRISIS  OF  1907  639 

the  discrepancy  between  anticipated  and  actual  values  turned 
out  not  to  be  so  excessive. 

When  we  come  particularly  to  the  crisis  of  1907,  we  find 
that  the  general  causes  were  very  much  the  same.  The  last 
decade  has  been  characterized  by  the  most  unexampled  pros- 
perity in  our  history.  The  most  striking  initial  cause  is  the 
prodigious  increase  in  the  gold  supply.  Whereas  the  annual 
average  value  of  the  output  of  gold  was  under  one  hundred 
millions  in  the  first  half  of  the  eighties,  and  only  a  hundred 
and  twelve  millions  in  the  second  half,  it  has  grown  with  such 
enormous  strides  that  during  the  past  two  years  it  has  reached 
an  annual  value  of  about  four  hundred  millions.  The  result 
has  been  a  constant  rise  of  prices  from  the  minimum  level  of 
1896.  The  rapid  accumulation  of  gold,  much  of  which  went 
into  the  bank  reserves,  enabled  the  financial  institutions  to 
expand  their  credit  facilities  many  fold,  and  as  a  consequence 
enterprise  flourished  in  every  direction.  During  the  last 
decade  the  record  crops  of  cereals  and  cotton,  the  extension  of 
dry  farming,  the  effects  of  irrigation  on  fruit  culture,  the  de- 
velopment of  truck  farms,  and  the  unparalleled  increase  of 
immigration  led  to  a  remarkable  enhancement  of  land  values 
throughout  the  length  and  breadth  of  the  land ;  the  output  of 
coal  doubled,  that  of  petroleum  more  than  doubled,  and  that 
of  pig  iron,  as  well  as  of  steel,  actually  trebled;  the  huge  com- 
binations of  capital,  now  spreading  to  every  form  of  enter- 
prise, effected  prodigious  economies  and  revolutionized  busi- 
ness methods;  and  the  transition  from  the  agricultural  to  the 
industrial  phase  of  economic  development  proceeded  with 
unlooked-for  celerity.  Values  were  pushed  up  on  all  sides 
and  the  hopes  of  a  prosperous  community  were  capitalized 
with  a  recklessness  born  of  unbounded  faith.  The  pace  was 
too  rapid;  the  reaction  was  bound  to  ensue.  In  the  late 
autumn  of  1907  the  revulsion  was  precipitated,  with  all  the 
familiar  accompaniments  of  an  acute  panic  such  as  the  collapse 
of  several  financial  institutions,  the  sudden  curtailment  of 
loans,  leading  to  the  failures  of  some  prominent  business  con- 
cerns, the  hoarding  of  money,  the  appearance  of  a  premium  on 
currency,  going  to  over  3  per  cent.,  and  the  frantic  efforts 
of  the  financiers  to  relieve  the  situation  by  the  importation 


640  CRISES 

of  gold,  the  issue  of  clearing-house  certificates  and  the  inter- 
ference of  Government  through  the  dubious  expedients  of 
the  placing  of  a  new  bond  issue  and  the  emission  of  Treasury 
loan  certificates. 

The  crisis  of  1907,  however,  is  on  the  whole  not  comparable 
either  to  that  of  1857  or  to  that  of  1873,  for  reasons  which 
have  thus  far  perhaps  not  been  adequately  discussed.  These 
reasons  may  be  classed  under  five  heads. 

In  the  first  place,  the  very  magnitude  of  the  country's  re- 
sources has  been  a  favorable  factor.  The  unparalleled  pros- 
perity of  the  past  decade  has  made  possible  the  accumulation 
of  a  vast  reserve  in  the  case,  not  only  of  the  great  corporations, 
but  also  of  the  average  business  man.  This  reserve  has  acted 
as  a  buffer  to  the  shock  of  reaction,  and  has  softened  the 
impact  through  a  speedy  restoration  of  confidence  in  the  ex- 
cellence of  the  country's  assets  and  in  the  real  solvency  of 
business. 

Secondly,  the  crops,  while  not  those  of  a  bumper  year,  have 
been  large  and  valuable.  It  is  significant  that  almost  each  of 
our  great  crises  in  the  past  has  been  preceded  either  by  the 
failure  of  the  harvest  at  home  or  by  the  existence  of  such  a 
bountiful  output  abroad  as  greatly  to  reduce  prices.  It  must 
be  remembered  that,  notwithstanding  all  recent  developments, 
this  country  is  still  primarily  agricultural,  and  that  upon  the 
varying  extent  of  our  great  staple  crops  depends  in  large 
measure  the  effective  demand  which  sets  and  keeps  in  motion 
the  wheels  of  business  activity.  By  a  fortunate  coincidence, 
the  crisis  was  attended  by  a  phenomenon  which  in  ordinary 
times  would  have  spelled  prosperity,  and  which  in  this  extra- 
ordinary conjuncture  helped  to  bring  back  normal  conditions. 

In  the  third  place,  the  overcapitalization  of  values  was  some- 
what less  conspicuous  than  hitherto  in  our  greatest  industry  — 
that  of  transportation.  Some  of  our  former  crises  have,  as 
we  know,  been  brought  on  primarily  by  the  speculative  build- 
ing of  railroads.  But  whereas  in  the  early  eighties  the  annual 
increase  of  construction  reached  ten  and  eleven  thousand  miles, 
during  the  past  five  years,  with  a  railway  system  three  times 
as  large,  the  annual  increment  of  new  construction  was  only 
four  or  five  thousand  miles.  The  consequence  has  been  that 


CRISIS  OF  1907  641 

with  the  rapid  upbuilding  of  the  country  the  railways  have 
grown  up  to  their  capitalization,  until  it  is  now  reasonably 
certain  that  there  has  been  for  some  little  time  scarcely  any 
actual  overcapitalization.  A  striking  proof  of  the  absence 
of  any  real  discrepancy  between  normal  values  and  the  capi- 
talization of  actual  earning  capacity  is  afforded  by  the  con- 
gestion of  traffic  of  a  year  or  two  ago;  and  even  with  only 
normal  business  activity  it  is  computed  that,  in  order  to  pre- 
vent this  congestion  in  future  and  to  maintain  the  railways  at 
a  reasonable  standard  of  efficiency,  there  will  be  required  an 
annual  investment  of  over  a  billion  dollars. 

Fourthly,  the  crisis  of  1907  was  preceded  by  a  period  of 
gradual  liquidation.  General  prices  of  commodities,  with  a 
few  notable  exceptions  like  that  of  copper,  were  indeed  high 
until  well-nigh  the  outbreak  of  the  panic.  But  the  prices  of 
securities  had  for  some  time  undergone  a  marked  shrinkage. 
Some,  quite  mistakenly,  attribute  this  shrinkage  to  lack  of 
confidence  engendered  by  the  governmental  policy  toward  in- 
dustry ;  others,  with  equal  readiness  and  no  less  extravagance, 
ascribe  it  to  the  distress  caused  by  the  exposure  of  the  methods 
of  "  high  finance "  in  positions  of  trusteeship.  In  reality, 
however,  the  depreciation  in  securities  was  caused  chiefly  by 
the  rise  in  the  rate  of  interest.  In  fact  the  one  phenomenon 
is  really  the  other ;  for  where  earnings  remain  unchanged,  the 
capitalization  of  the  earnings  depends  on  the  rate  of  interest. 
If  it  be  objected  that  the  price  of  stocks  fell  because  of  the 
apprehended  decrease  of  future  earnings,  due  to  lack  of  con- 
fidence, the  retort  is  obvious  that  this  would  not  suffice  to 
explain  the  equal  or  still  greater  fall  in  the  capital  value  of 
bonds,  private  or  public,  with  a  fixed  rate  of  interest.  The  de- 
preciation was  not  national,  but  international,  in  character; 
and  it  applied  not  only  to  our  railway  and  industrial  securities, 
but  to  the  English  "  Consols  "  as  well. 

The  rise  in  the  interest  rate,  which  explains  the  fall  in  the 
capital  value  of  securities,  was  due  to  several  causes.  First 
and  foremost  is  the  increase  in  the  gold  output.  For,  as  is 
now  well  established  by  economic  theory  and  reinforced  by 
the  observations  of  practical  men,  while  any  increase  in  the 
supply  of  loanable  funds  on  the  call-money  market  temporarily 


642  CRISES 

reduces  the  "money  rate,"  an  increase  in  the  general  supply 
of  standard  money  in  the  community,  on  the  contrary,  raises 
not  only  the  price  level  of  all  commodities,  but  the  price  for 
the  use  of  capital,  which  we  call  the  general  rate  of  interest. 
The  increase  of  money  as  the  standard  of  value  inevitably 
tends  to  increase  the  general  rate  of  interest.  Again,  since  the 
rate  of  interest  is  always  adjusted  to  the  earnings  of  the  fund 
of  capital  at  the  margin  of  its  employment,  the  rate  of  interest 
has  risen  because  there  has  been  relatively  less  capital  avail- 
able for  employment.  The  fund  of  free  capital  has  been 
rapidly  diminishing  during  the  past  few  years.  Hundreds  of 
millions  were  destroyed  in  the  Boer  and  Japanese  wars ;  hun- 
dreds of  millions  more  disappeared  through  the  destruction 
of  San  Francisco  and  Valparaiso;  and  countless  millions  in 
addition  have  been  utilized  to  finance  the  more  or  less  dubious 
schemes  which  have  sprung  up  in  all  countries  during  the 
years  of  prosperity.  Even  though  there  was  no  great  over- 
capitalization of  railroads  and  even  though  many  of  the  indus- 
trial enterprises  were  really  legitimate,  the  discounting  of  the 
future  was  not  quite  ample,  and  the  capital  was  invested  more 
rapidly  than  the  immediate  returns  would  warrant.  The  re- 
placement fund,  in  other  words,  was  neither  quite  large  enough 
nor  quite  active  enough;  and  with  the  gradual  exhaustion  of 
the  available  free  capital,  interest  rates  necessarily  rose  and 
security  values  as  a  consequence  fell. 

The  period  of  liquidation  was  thus  a  fortunate  event.  By 
checking  the  movement  of  exaltation  and  preventing  the  level 
of  prices  from  being  so  extreme,  it  kept  the  reaction  from 
being  so  great.  Where  the  crest  of  the  wave  is  lower,  the 
shock  of  its  break  is  less.  Had  the  ascent  of  prices  and  values 
gone  on  unhindered,  the  convulsion  of  1907  would  have  been 
far  more  severe.  From  this  point  of  view,  even  those  who 
mistakenly  persist  in  ascribing  the  lack  of  confidence  to  the 
President  ought  in  reality  to  be  grateful  to  him;  for  to  the 
extent  that  he  may  be  said  to  have  superinduced  the  liquida- 
tion of  the  spring  and  summer,  he  assuredly  contributed  to 
mitigate  the  shock  of  the  inevitable  reaction  in  the  autumn. 

The  fifth  and  final  cause  of  the  lesser  magnitude  of  the 
crisis  is  the  development  of  trusts.  Until  we  attain  the  right 


CRISIS  OF  1907  643 

perspective,  it  is  always  difficult  to  get  a  correct  view  of  the 
far-reaching  changes  which  are  taking  place  under  our  very 
eyes.  Especially  true  is  this  of  such  a  veritable  revolution  as 
is  typified  by  the  modern  concentration  and  integration  of 
industry  into  the  vast  combinations  known  as  trusts.  There 
are  indeed  many  disquieting  and  untoward  symptoms  in  the 
development  of  which  this  is  not  the  place  to  speak.  But  as 
against  the  undoubted  perils  of  what  we  are  all  now  coming 
to  recognize  as  an  inevitable  process,  we  sometimes  forget  to 
put  at  least  one  countervailing  advantage  which  is  of  especial 
importance  in  this  connection.  The  modern  trust,  as  typified 
in  its  most  developed  form  by  the  United  States  Steel  Cor- 
poration, is  apt  to  exert  an  undeniably  steadying  influence  on 
prices.  Precisely  because  of  the  immense  interests  at  stake, 
and  the  danger  of  a  reaction,  the  trust  with  its  consummately 
able  management  tends  toward  conservatism.  As  compared 
with  the  action  of  a  horde  of  small  competitors  under  similar 
conditions,  it  is  apt  during  a  period  of  prosperity  to  refrain 
from  marking  up  prices  to  the  top  notch,  and  is  likely  to  make 
a  more  adequate  provision  for  the  contingencies  of  the  market. 
With  this  greater  moderation  is  apt  to  be  associated  a  more 
accurate  prevision,  which  succeeds  in  a  more  correct  adjust- 
ment of  present  investment  to  future  needs.  The  drift  of 
business  enterprise  in  its  newer  form  is  thus  toward  a  relative 
checking  of  the  discrepancy  between  estimated  and  actual  earn- 
ings, or,  in  other  words,  toward  a  retardation  in  the  process 
of  overcapitalization.  The  history  of  trusts  is  still  too  recent, 
and  in  not  all  of  them  are  we  yet  able  to  discern  the  working 
out  of  what  ultimately  will  come  to  be  recognized  as  the  real 
laws  of  their  evolution.  To  those,  however,  who  compre- 
hend what  this  revolution  in  business  enterprise  really  implies, 
it  can  scarcely  be  doubted  that  the  fruit  of  this  steadying 
influence  and  of  the  better  adaptation  of  the  present  to  the 
future  is  already  perceptible.  Notwithstanding  the  quite  un- 
exampled prosperity  of  the  last  decade,  the  tempo  of  over- 
capitalization has  been  relatively  less  rapid  and  the  process  of 
readjustment  throughout  the  world  of  enterprise  has  therefore 
been  less  extreme.  Industry  has  slackened  rather  than  col- 
lapsed, and  the  disturbance  itself  has  been  comparatively 


'644  CRISES 

short-lived,  with  the  prospects  of  an  early  rebound.  The  in- 
fluence of  trusts  in  moderating  crises  and  in  minimizing  de- 
pressions will  doubtless  become  more  apparent  with  each  en- 
suing decade  in  the  history  of  modern  industry. 

While  the  general  causes  which  are  responsible  for  the 
crisis  of  1907  have  been  recounted  above,  there  still  remains 
one  point  of  fundamental  importance.  If  we  compare  our 
economic  history  with  that  of  Europe,  we  observe  that  acute 
financial  crises  have  there  almost  passed  away.  England  has 
had  no  severe  convulsion  since  1866,  and  in  France  and  Ger- 
many also  the  disturbances  are  more  and  more  assuming  the 
form  of  periodic  industrial  depressions  rather  than  of  acute 
financial  crises.  The  responsibility  for  the  continuance  in  this 
country  of  a  phenomenon  which  is  in  large  measure  vanishing 
elsewhere  rests  beyond  all  perad venture  of  doubt  on  the  in- 
adequacy of  our  currency  system. 

CURRENT  THEORIES  OF  CRISES 
TWO  POINTS  OF  AGREEMENT 

1  Wide  divergences  of  opinion  continue  to  exist  among 
competent  writers  upon  crises;  but  in  recent  years  substantial 
agreement  has  been  reached  upon  two  points  of  fundamental 
importance. 

Crises  are  no  longer  treated  as  sudden  catastrophes  which 
interrupt  the  "  normal "  course  of  business,  as  episodes  which 
can  be  understood  without  investigation  of  the  intervening 
years.  On  the  contrary,  the  crisis  is  regarded  as  but  the  most 
dramatic  and  the  briefest  of  the  three  phases  of  a  business 
cycle  —  prosperity,  crisis,  and  depression.2  Modern  dis- 

1  Wesley  Clair  Mitchell,  Business  Cycles,  />/>.  5-19.    The  University  of 
California  Press.     Berkeley,   1913. 

2  The  not  infrequent  statement  that  prosperity  sometimes  merges  into 
depression   without   the   intervention   of   a  crisis   means   simply  that   the 
writers  understand  by  crisis  a  violent  disturbance  of  business  conditions. 
It   is   in   closer   accord   with   every-day   usage   to   call   such   occurrences 
"  panics,"  and  to  apply  the  term   "  crisis "  to  the  transition   from  pros- 
perity to  depression  even  when  accomplished  quietly.     On  closer  inspection, 
a  business  cycle  is  often  found  to  be  complicated  by  minor  changes,  such 
as  the  interruption  of  depression  by  a  premature  resumption  of  activity, 
the  occurrence  of  a  pause  or  even  a  slight  crisis  in  the  midst  of  prosperity, 
and  the  like.     But  for  the  present  it  is  wise  to  confine  attention  to  the 
broadest  features  bf  the  cycle. 


COMPETITION  THEORY  645 

cussions  endeavor  to  show  why  a  crisis  is  followed  by  de- 
pression, and  depression  by  prosperity,  quite  as  much  as  to 
show  why  prosperity  is  followed  by  a  crisis.  In  a  word,  the 
theory  of  crises  has  grown  into  the  theory  of  business  cycles.1 
This  wider  grasp  of  the  problem  has  discredited  the  view 
that  crises  are  due  to  abnormal  conditions  which  tempt  in- 
dustry and  trade  to  forsake  their  beaten  paths  and  temporarily 
befog  the  judgment  of  business  men  and  investors,  or  to  mis- 
guided legislation,  unsound  business  practices,  imperfect 
banking  organization,  and  the  like.2  As  business  cycles  have 
continued  to  run  their  round  decade  after  decade  in  all  na- 
tions of  highly  developed  business  organization,  the  idea  that 
each  crisis  may  be  accounted  for  by  some  special  cause  has 
become  less  tenable.  On  the  contrary,  the  explanations  in 
favor  to-day  ascribe  the  recurrence  of  crises  after  periods 
of  prosperity  to  some  inherent  characteristic  of  economic  or- 
ganization or  activity.  The  complex  processes  which  make 
up  business  life  are  analyzed  to  discover  why  they  inevitably 
work  out  a  change  from  good  times  to  bad  and  from  bad  times 
to  good.  The  influence  of  special  conditions  is  admitted,  of 
course,  but  rather  as  a  factor  which  complicates  the  process 
than  as  the  leading  cause  of  crises.  . 

BEVERIDGE'S  "  COMPETITION  THEORY  " 

Among  these  theories  which  seek  to  account  not  for  crises 
but  for  the  cyclical  fluctuations  of  economic  activity,  the 
"  competition  theory  "  tentatively  advanced  by  Beveridge  is 
one  of  the  simplest. 

In  most  instances,  he  begins,  production  is  carried  on  by 
several  or  many  establishments,  each  acting  independently, 
and  each  seeking  to  do  as  large  a  share  of  the  business  as 
possible.  Whenever  the  demand  for  their  wares  increases, 
each  competitor  tries  to  engross  a  larger  portion  of  the  mar- 
ket. "  Inevitably,  therefore,  all  the  producers  together  tend 
to  overshoot  the  demand  and  to  glut  the  market  for  a  time. 
This  is  a  result  not  of  wild  speculation  nor  of  miscalculation 

1  Compare   W.    Sombart,    Versuch,   einer  Systcmatik   dcr   Wirtschafts- 
kriscn,  Archiv  fur  Sozialwissenschaft,  1904,  pp.  1-21. 

2  The  first  type  of  theories  mentioned  in  the  preceding  section. 


646  CRISES 

of  the  total  demand;  it  must  be  a  normal  incident  wherever 
competition  has  a  place  at  all."  Such  activity  among  pro- 
ducers constitutes  the  period  of  prosperity.  But  sooner  or 
later  the  glutting  of  the  market  becomes  apparent,  and  then 
the  crisis  comes,  because  the  goods  cannot  all  be  sold  at  a 
profit.  Prices  fall,  production  is  checked,  and  a  period  of 
depression  ensues.  Gradually,  however,  the  slackened  rate 
of  production  allows  the  accumulated  stocks  to  be  cleared, 
perhaps  below  cost  price,  perhaps  by  waiting  until  demand 
grows  up  to  supply.  When  this  excess  of  demand  over  supply 
has  once  again  become  patent,  business  recovers.  Depression 
yields  to  prosperity,  competitors  again  vie  with  each  other  to 
increase  their  shares  in  the  output,  after  a  few  years  the 
market  is  glutted  again,  and  a  new  crisis  comes,  to  be  followed 
once  more  by  depression.  Thus  business  cycles  are  due  in  the 
last  resort  to  "  the  simple  and  well  nigh  universal  fact  of  in- 
dustrial competition."  1 

MAY'S    THEORY    OF   THE   DISCREPANCY   BETWEEN    WAGES    AND 

PRODUCTIVITY 

Like  Beveridge,  May  conceives  crises  to  result  immediately 
from  the  glutting  of  markets  for  industrial  products.  But 
May  offers  a  quite  different  analysis  of  the  cause  of  gluts. 
The  continually  growing  productivity  of  industry  makes 
necessary  a  corresponding  growth  of  the  market,  if  disaster 
is  to  be  avoided.  But  to  enable  producers  to  sell  their  grow- 
ing output  promptly  prices  must  be  reduced  and  wages  must 
be  raised  in  proportion  as  the  supply  of  goods  increases.  For 
it  is  only  by  combining  an  increase  in  the  money  income  of 
the  mass  of  the  population  with  a  decrease  in  the  cost  of  com- 
modities that  a  country's  home  markets  can  be  kept  expanding 
with  the  progress  of  industrial  methods.  Periods  of  pros- 
perity attended  by  rising  prices  necessarily  violate  this  condi- 
tion of  business  hygiene  and  inevitably  end  by  glutting  mar- 
kets. Then  come  crises,  which  restore  the  body  politic  to 
health  by  forcing  down  prices  to  the  point  where  consumers 
can  purchase  the  supplies  which  are  offered.  The  germ  of 
the  trouble,  then,  is  the  tendency  of  prices  to  rise  during 

1 W.  H.  Beveridge,  Unemployment,  ed.  3  (I^ndon,  1912),  chapter  iv. 


THEORY  OF  OVER-SAVING  647 

periods  of  increasing  productivity.  Accordingly,  May  urges 
as  remedy  a  legal  limitation  of  the  rate  of  profits,  in  order 
that  producers  may  be  forced  to  reduce  prices  as  they  increase 
output.1 

HOBSON'S  THEORY  OF  OVER-SAVING 

A  third  explanation  of  how  markets  come  to  be  glutted 
periodically  is  offered  by  Hobson's  theory  of  over-saving. 
Hobson  holds  that  at  any  given  time  "  there  is  an  exact  pro-- 
portion  of  the  current  income  which,  in  accordance  with  exist- 
ing arts  of  production  and  existing  foresight,  is  required  to 
set  up  new  capital  so  as  to  make  provision  for  the  maximum 
consumption  throughout  the  near  future."  Now,  if  in  a 
period  of  prosperity  the  rate  of  consumption  should  rise  pari 
passu  with  the  rate  of  production,  there  is  no  inherent  reason 
why  the  prosperity  might  not  continue  indefinitely.  But  in 
modern  societies,  a  considerable  portion  of  the  wealth  pro- 
duced belongs  to  a  small  class.  In  active  times  their  incomes 
rise  more  rapidly  than  their  consumption  and  the  surplus  in- 
come is  perforce  saved.  There  results  for  the  community  as 
a  whole  a  slight  deficiency  of  spending  and  a  corresponding 
excess  of  saving.  The  wealthy  class  seeks  to  invest  its  new 
savings  in  productive  enterprises  —  thereby  increasing  the 
supply  of  goods  and  also  increasing  the  incomes  from  which 
further  savings  will  be  made.  This  process  runs  cumulatively 
during  the  years  of  prosperity  until  finally  the  markets  be- 
come congested  with  goods  which  cannot  be  sold  at  a  profit. 
Then  prices  fall,  liquidation  ensues,  capital  is  written  down, 
and  the  incomes  of  the  wealthy  class  are  so  reduced  that 
savings  fall  below  the  proper  proportion  to  spending.  Dur- 
ing this  period  of  depression  the  glut  of  goods  weighing  upon 
the  market  is  gradually  worked  off,  and  the  prospect  of  profit- 
able investment  slowly  returns.  Saving  rises  again  to  the 
right  proportion  to  spending  and  good  times  prevail  for  a 
season.  But  after  a  while  the  chronic  impulse  towards  over- 
saving becomes  fully  operative  once  more,  and  soon  or  late 
begets  another  congestion  of  the  markets  and  this  congestion 
begets  another  depression.  Proximately,  then,  the  cause  of 

1  R.  E.  May,  Das  Grundgesets  der  Wirtschaftskrisen  (Berlin,  1902). 


(648  CRISES 

alternating  prosperity  and  depression  is  the  tendency  toward 
over-saving;  ultimately  it  is  the  existence  of  the  surplus  in- 
comes which  lead  to  over-saving.1 

HULL'S  THEORY  OF  THE   CHANGING  COSTS   OF   CONSTRUCTION 

An  American  business  man,  George  H.  Hull,  has  recently 
drawn  from  his  experience  of  practical  affairs  conclusions 
which  resemble  those  drawn  by  [a  German]  Professor  Spiet- 
hoff,  from  his  theoretical  analysis  of  economic  records. 
High  prices  of  construction,  runs  his  thesis,  is  the  hitherto 
"  unknown  cause  of  the  mysterious  depressions  "  from  which 
the  industrial  nations  suffer. 

In  demonstrating  thh  thesis,  Hull  contends  that  agriculture, 
commerce,  and  finance  fluctuate  within  relatively  narrow  lim- 
its. Agriculture  provides  the  necessities  of  life,  commerce 
distributes  them,  and  finance  adjusts  the  bills.  The  volume 
of  all  this  business  is  fairly  constant,  because  the  demand  for 
necessities  is  incapable  of  sudden  expansion  or  contraction. 
Industry,  on  the  contrary,  may  expand  or  contract  indefinitely 
—  especially  that  part  of  industry  devoted  to  construction 
work.  For  the  sources  of  "  booms  "  and  depressions,  there- 
fore, we  must  look  to  the  enterprises  which  build  and  equip 
houses,  stores,  factories,  railways,  docks,  and  the  like. 

Of  the  huge  total  of  construction,  which  Hull  believes  to 
make  over  three-quarters  of  all  industrial  operations,  at  least 
two-thirds,  even  in  the  busiest  of  years,  consists  of  repairs, 
replacements,  and  such  extensions  as  are  required  by  the 
growth  of  population.  This  portion  of  construction  is  neces- 
sary and  must  be  executed  every  year.  But  the  remaining 
portion  is  "  optional  construction,"  and  is  undertaken  or  not 
according  as  investors  see  a  liberal  or  a  meagre  profit  in  pro- 
viding new  equipment. 

Now,  when  the  costs  of  construction  fall  low  enough  to 
arouse  "  the  bargain-counter  instinct,"  many  of  "  the  far- 
seeing  ones  who  hold  the  purse-strings  of  the  country  "  let 
heavy  contracts,  and  their  example  is  followed  by  the  less 
shrewd.  The  addition  of  the  resulting  new  business  to  the 

1 1  have  followed  Mr.  Hobson's  latest  exposition,  The  Industrial  System 
(London,  1909),  chapters  iii  and  xviii. 


UNEVEN  BUSINESS  EXPANSION  649 

regular  volume  of  "  necessity  construction  "  plus  the  provision 
of  ordinary  consumers'  goods  creates  a  "  boom."  But,  after 
a  year  or  two,  contractors  discover  that  their  order  books  call 
for  more  work  than  they  can  get  labor  and  materilas  to  finish 
on  contract  time.  When  this  oversold  condition  of  the  con- 
tracting trades  is  realized,  the  prices  of  labor  and  of  raw  ma- 
terials rise  rapidly.  The  estimated  cost  of  construction  on 
new  contracts  then  becomes  excessive.  Shrewd  investors 
therefore  begin  to  defer  the  execution  of  their  plans  for  ex- 
tending permanent  equipment,  and  the  letting  of  fresh  con- 
tracts declines  apace.  As  they  gradually  complete  work  on 
their  old  contracts,  all  the  enterprises  'making  iron,  steel,  lum- 
ber, cement,  brick,  stone,  etc.,  then  face  a  serious  shrinkage 
of  business.  Just  as  the  execution  of  the  large  contracts  for 
"  optional  construction,"  let  in  the  low-priced  period,  brought 
on  prosperity,  so  the  smallness  of  such  contracts,  let  in  the 
high-price  period,  now  brings  on  depression.  Then  the  prices 
of  construction  fall  until  they  arouse  "  the  bargain-counter  in- 
stinct "  of  investors  once  more,  and  the  cycle  begins  afresh. 

While  Hull  grants  that  panics  are  often  caused  by  strictly 
financial  disorders,  he  holds  that  all  industrial  depressions  are 
caused  by  high  prices  of  construction,  and  foreshadowed  by 
high  prices  of  iron.  Consequently  he  believes  that  depressions 
could  be  prevented  from  occurring  if  the  Government  would 
collect  and  publish  monthly  "  all  pertinent  information  in  re- 
lation to  the  existing  volume  of  construction  under  contract 
for  future  months,  and  all  pertinent  information  in  relation  to 
the  capacity  of  the  country  to  produce  construction  materials 
to  meet  the  demand  thus  indicated."  1 

SOMBART'S   THEORY   OF  THE  UNEVEN   EXPANSION   IN   THE 
PRODUCTION  OF  ORGANIC  AND  INORGANIC  GOODS 

Sombart,  like  many  of  the  recent  German  writers,  finds  ill- 
proportioned  production  the  chief  cause  of  crises;  but  he  thinks 
it  inaccurate  to  say  that  the  over-production  is  in  industrial 
equipment.  For  during  the  German  "  boom  "  which  collapsed 
in  1900-01,  over-production  was  quite  as  marked  in  industries 
making  equipment  for  electric  lighting  systems,  telephone 

1  George  H.  Hull,  Industrial  Depressions  (New  York,  1911),  p.  218. 


650  CRISES 

plants,  street  railways,  dwellings,  bicycles,  etc.,  as  in  industries 
making  machines.  The  real  lack  of  proportion  he  sees  in  the 
unlike  degree  of  expansion  in  industries  using  organic  and  in- 
organic materials.  The  inorganic  industries,  typified  by  steel, 
can  expand  to  an  enormous  extent  within  a  brief  period  with- 
out being  seriously  hampered  by  scarcity  of  raw  materials. 
The  organic  industries,  typified  by  cotton-spinning,  on  the 
contrary,  are  always  in  precarious  dependence  upon  the  year's 
harvests.  In  the  organic  industries,  one  may  say,  the  condi- 
tion of  business  is  determined  by  the  harvests ;  in  the  inorganic 
industries  the  condition  of  business  determines  the  production 
of  raw  materials.  The  modern  crisis,  then,  following  upon 
a  period  of  prosperity,  is  substantially  the  result  of  the  dif- 
ferent rhythm  of  production  in  the  organic  and  inorganic 
realms.  The  organic  industries  dependent  upon  harvests  can- 
not keep  pace  with  the  inorganic  when  the  latter  are  being 
rapidly  extended  by  heavy  investments  of  capital.1 


Carver  has  suggested  a  way  of  accounting  for  business 
cycles  by  applying  the  laws  of  value  which  govern  producers' 
goods.  He  points  out  that  a  comparatively  small  change  in  a 
factory's  selling  prices  will  cause  a  much  greater  change  in  its 
profits,  if  volume  of  output  and  expenses  remain  the  same. 
Since  the  value  of  the  factory  as  a  going  concern  is  the  capi- 
talized value  of  its  prospective  profits,  a  large  increase  of 
profits  will  cause  a  large  increase  of  the  factory's  value,  pro- 
vided the  high  profits  are  expected  to  continue  long.  Hence 
the  law  that  "  the  value  of  producers'  goods  tends  to  fluctuate 
more  violently  than  the  value  of  consumers'  goods."  It  fol- 
lows that: 

"  A  slight  rise  in  the  price  of  consumers'  goods  will  so  increase 
the  value  of  the  producers'  goods  which  enter  into  their  production 
as  to  lead  to  larger  investments  in  producers'  goods.  The  resulting 
larger  market  for  producers'  goods  again  stimulates  the  product'on 
of  such  goods,  and  withdraws  productive  energy  from  the  creation 


1  W.  Somhart,  Die  St'tniiificii  im  dtvtschen  JVirtschaftsleben,  Schriften 
des  Vereins  fur  Socialpolitik,  vol.  113,  pp.  130-133. 


LAGGING  ADJUSTMENT  OF  INTEREST  65 1 

of  consumers'  goods.  This  for  the  time  tends  to  raise  the  price  of 
consumers'  goods  still  higher,  and  this  agam  to  stimulate  still  fur- 
ther the  creation  of  producers'  goods.  There  is  no  check  to  this 
tendency  until  the  new  stock  of  producers'  goods  begin  to  pour  upon 
the  market  an  increased  flow  of  consumers'  goods.  This  tends  to 
produce  a  fall  in  their  value,  which  in  turn  produces  a  still  greater 
fall  in  the  value  of  producers'  goods,  and  so  the  process  goes." 

Thus,  once  more,  prosperity  breeds  crisis  and  depression; 
but  this  time  the  reason  is  found  in  the  dissimilar  fluctuations 
which  the  laws  of  value  establish  for  the  goods  which  people 
use  and  the  equipment  with  which  they  are  made.1 

FISHER'S  THEORY  OF  THE  LAGGING  ADJUSTMENT  OF 
INTEREST 

Another  interesting  suggestion  comes  from  Irving  Fisher. 
By  statistics  he  has  shown  that  when  for  any  reason  prices 
begin  to  rise,  interest  rates  advance,  but  not  fast  enough  to 
offset  the  decline  in  the  purchasing  power  of  the  principal 
caused  by  the  rise  of  prices.  During  such  periods,  accord- 
ingly, borrowers  on  the  whole  get  the  better  of  lenders  and 
make  high  profits.  Since  the  borrowers  consist  largely  of 
active  business  men,  precisely  the  class  of  greatest  foresight, 
they  grasp  the  situation  more  quickly  than  lenders.  As  a  re- 
sult of  their  desire  to  profit  by  their  opportunity,  loans  are 
rapidly  extended.  This  extension  is  effected  largely  by  the 
lending  of  bank  credits,  that  is,  by  the  increasing  of  deposit 
currency.  The  greater  volume  of  the  currency  combines  with 
more  rapid  circulation  of  money  and  checks  to  increase  prices 
again,  and  so  to  start  the  whole  process  anew  on  a  higher 
level.  "  There  is  thus  set  up  a  vicious  circle,  which  will  con- 
tinue just  as  long  as  the  rate  of  interest  fails  to  make  a 
proper  adjustment  to  put  on  the  brakes  and  prevent  over- 
borrowing." 

"  But  the  rise  in  interest,  though  belated,  is  progressive, 
and,  as  soon  as  it  overtakes  the  rate  of  rise  in  prices,  the  whole 
situation  is  changed."  Borrowers  can  no  longer  hope  to 
make  great  profits,  and  the  demand  for  loans  ceases  to  ex- 

1  T.  N.  Carver,  "  A  Suggestion  for  a  Theory  of  Industrial  Depressions," 
Quarterly  Journal  of  Economics,  May,  1903,  pp.  497-500. 


652  CRISES 

pand.  Further,  the  higher  rate  of  interest  reduces  the  price 
of  many  of  the  securities  used  as  collateral  for  loans.  Busi- 
ness men  "  who  have  counted  on  renewing  their  loans  at  the 
former  rates  and  for  the  former  amounts  are  unable  to  do 
so.  It  follows  that  some  of  them  are  destined  to  fail." 
There  follow  suspicions  regarding  the  solvency  of  the  banks, 
runs  for  cash,  forced  curtailment  of  loans,  and  exceedingly 
high  rates  of  interest  —  in  short,  the  phenomena  of  crisis. 

The  contraction  of  loans  is  accompanied  by  a  reduction  of 
deposit  currency  and  a  slower  circulation  both  of  money  and 
of  checks.  Hence  prices  decline.  Again  the  rate  of  interest 
follows;  but  just  as  it  was  slow  to  rise  so  now  it  is  slow  to 
fall.  Then  the  business  men  who  borrow  find  that  the  slug- 
gish adjustment  of  interest  reduces  their  profits.  Therefore 
loans,  and  the  deposits  based  on  loans,  contract  again.  But 
the  shrinking  volume  of  deposit  currency  causes  a  further 
fall  of  prices,  and  once  more  interest  lags  behind  and  renews 
the  process.  Thus  the  phase  of  depressions  runs  cumula- 
tively until  at  last  the  progressive  reduction  of  interest  has 
overtaken  the  fall  of  prices.  At  this  point  business  men  find 
their  profits  rising  to  the  normal  level.  Borrowing  becomes 
freer,  the  volume  of  deposit  currency  swells,  prices  start  up- 
ward, and  the  cycle  begins  afresh.1 

Beveridge  ascribes  crises  to'  industrial  competition,  May  to 
the  disproportion  -between  the  increase  in  wages  and  in  pro- 
ductivity, Hobson  to  over-saving,  .  .  .  Hull  to  high  costs  of 
construction,  Lescure  to  declining  prospects  of  profits,  .  .  . 
[Seligman]  to  a  discrepancy  between  anticipated  profits  and 
current  capitalization,  Sombart  to  the  unlike  rhythm  of  pro- 
duction in  the  organic  and  inorganic  realms,  Carver  to  the 
dissimilar  price  fluctuations  of  producers'  and  consumers' 
goods,  Fisher  to  the  slowness  with  which  interest  rates  are 
adjusted  to  changes  in  the  price  level. 

One  seeking  to  understand  the  recurrent  ebb  and  flow  of 

1  Irving  Fisher,  The  Purchasing  Pazver  of  Money  (New  York,  1911), 
chapter  iv,  and  chapter  xi,  §§  15,  16,  17.  Compare  the  same  writer's  sum- 
mary statement  of  his  theory  in  Moody's  Magazine,  February,  1009,  pp. 
110-114,  and  H.  G.  Brown's  paper  "Typical  Commercial  Crises  -versus  A 
Money  Panic,"  Yale  Review,  August,  1910. 


MITCHELL'S  ECLECTIC  THEORY  653 

economic  activity  characteristic  of  the  present  day  finds  these 
numerous  explanations  both  suggestive  and  perplexing.  All 
are  plausible,  but  which  is  valid?  None  necessarily  excludes 
all  the  others,  but  which  is  the  most  important?  Each  may 
account  for  certain  phenomena ;  does  any  one  account  for  all 
the  phenomena?  Or  can  these  rival  explanations  be  com- 
bined in  such  a  fashion  as  to  make  a  consistent  theory  which 
is  wholly  adequate? 

MITCHELL'S  THEORY  OF  BUSINESS  CYCLES 

1  Only  by  putting  any  theory  to  the  practical  test  of  ac- 
counting for  actual  business  experience  can  its  value  be  de- 
termined. The  case  for  the  present  theory,  therefore,  and 
also  the  case  against  it,  is  to  be  found  not  in  the  easy  summary 
which  follows,  but  in  the  difficult  chapters  which  precede,2 
or  better  still  in  an  independent  effort  to  use  it  in  interpreting 
the  ceaseless  ebb  and  flow  of  economic  activity. 

I.    THE    CUMULATION    OF    PROSPERITY 

With  whatever  phase  of  the  business  cycle  analysis  begins, 
it  must  take  for  granted  the  conditions  brought  about  by  the 
preceding  phase,  postponing  explanation  of  these  assumptions 
until  it  has  worked  around  the  cycle  and  come  again  to  its 
starting  point. 

A  revival  of  activity,  then,  starts  with  this  legacy  from 
depression :  a  level  of  prices  low  in  comparison  with  the  prices 
of  prosperity,  drastic  reductions  in  the  costs  of  doing  busi- 
ness, narrow  margins  of  profit,  liberal  bank  reserves,  a  con- 
servative policy  in  capitalizing  business  enterprises  and  in 
granting  credits,  moderate  stocks  of  goods,  and  cautious 
buying. 

For  reasons  which  will  appear  in  the  sequel,  such  condi- 
tions are  accompanied  by  an  expansion  in  the  physical  volume 
of  trade.  Though  slow  at  first,  this  expansion  is  cumulative. 
Now  it  is  only  a  question  of  time  when  an  increase  in  the 

1  Adapted   from  Wesley  Clair  Mitchell,   Business  Cycles,  pp.  571-579- 
The  University  of  California  Press.     1913. 

2  The  extract  here  reproduced  is  from  the  concluding  chapter  of  the 
work  indicated.  — EDITOR. 


654  CRISES 

amount  of  business  transacted  which  grows  more  rapid  as  it 
proceeds  will  turn  dullness  into  activity.  Left  to  itself,  this 
transformation  is  effected  by  slow  degrees;  but  it  is  often 
hastened  by  some  propitious  event  arising  from  other  than 
domestic  business  sources,  such  as  exceptionally  profitable 
harvests,  heavy  purchases  of  supplies  by  Government,  or  a 
marked  increase  in  the  export  demand  for  the  products  of 
home  industry. 

Even  when  a  revival  of  activity  is  confined  at  first  within 
a  narrow  range  of  industries  or  within  some  single  section 
of  the  country,  it  soon  spreads  to  other  parts  of  the  business 
field.  For  the  active  enterprises  must  buy  more  materials, 
wares,  and  current  supplies  from  other  enterprises,  the  latter 
from  still  others,  and  so  on  without  assignable  limits.  Mean- 
while all  enterprises  which  become  busier  employ  more  labor, 
use  more  borrowed  money,  and  make  higher  profits.  There 
results  an  increase  in  family  incomes  and  an  expansion  of 
consumers'  demand,  which  likewise  spreads  out  in  ever  widen- 
ing circles.  Shopkeepers  pass  on  larger  orders  for  con- 
sumers' goods  to  wholesale  merchants,  manufacturers,  im- 
porters, and  producers  of  raw  materials.  All  these  enter- 
prises require  more  supplies  of  various  kinds  for  handling 
their  growing  trade,  and  increase  the  sums  which  they  pay 
out  to  employes,  lenders,  and  proprietors  —  thus  stimulating 
afresh  the  demand  for  both  producers'  and  consumers'  goods. 
Soon  or  late  this  expansion  of  orders  reaches  back  to  the  en- 
terprises from  which  the  impetus  to  greater  activity  was  first 
received,  and  then  this  whole  complicated  series  of  reactions 
begins  afresh  at  a  higher  pitch  of  intensity.  All  this  while, 
the  revival  of  activity  is  instilling  a  feeling  of  optimism 
among  business  men,  and  this  feeling  both  justifies  itself  and 
heightens  the  forces  which  engendered  it  by  making  every  one 
readier  to  buy  with  freedom. 

While  the  price  level  is  often  sagging  slowly  when  a  re- 
vival begins,  the  cumulative  expansion  in  the  physical  volume 
of  trade  presently  stops  the  fall  and  starts  a  rise.  For,  when 
enterprises  have  in  sight  as  much  business  as  they  can  handle 
with  their  existing  facilities  of  standard  efficiency,  they  stand 
out  for  higher  prices  on  additional  orders.  This  policy 


MITCHELL'S  ECLECTIC  THEORY  655 

prevails  even  in  the  most  keenly  competitive  trades,  because 
additional  orders  can  be  executed  only  by  breaking  in  new 
hands,  starting  old  machinery,  buying  new  equipment,  or 
making  some  other  change  which  involves  increased  expense. 
The  expectation  of  its  coming  hastens  the  advance.  Buyers 
are  anxious  to  secure  or  to  contract  for  large  supplies  while 
the  low  level  of  quotations  continues,  and  the  first  definite 
signs  of  an  upward  trend  of  quotations  brings  out  a  sudden 
rush  of  orders. 

Like  the  increase  in  the  physical  volume  of  business,  the 
rise  of  prices  spreads  rapidly;  for  every  advance  of  quota- 
tions puts  pressure  upon  some  one  to  recoup  himself  by  mak- 
ing a  compensatory  advance  in  the  prices  of  what  he  has  to 
sell.  The  resulting  changes  in  prices  are  far  from  even,  not 
only  as  between  different  commodities,  but  also  as  between 
different  parts  of  the  system  of  prices.  Retail  prices  lag  be- 
hind wholesale,  the  prices  of  staple  consumers'  behind  the 
prices  of  staple  producers'  goods,  and  the  prices  of  finished 
products  behind  the  prices  of  their  raw  materials.  Among 
raw  materials,  the  prices  of  mineral  products  reflect  the 
changed  business  conditions  more  regularly  than  do  the  prices 
of  raw  animal,  farm,  or  forest  products.  Wages  rise  often 
more  promptly,  but  always  in  less  degree  than  wholesale 
prices;  discount  rates  rise  sometimes  more  slowly  than  com- 
modities and  sometimes  more  rapidly;  interest  rates  on  long 
loans  always  more  sluggishly  in  the  early  stages  of  revival, 
while  the  prices  of  stocks  —  particularly  of  common  stocks 
—  both  precede  and  exceed  commodity  prices  on  the  rise. 
The  causes  of  these  differences  in  the  promptness  and  the 
energy  with  which  various  classes  of  prices  respond  to  the 
stimulus  of  business  activity  'are  found  partly  in  differences 
of  organization  between  the  markets  for  commodities,  labor, 
loans,  and  securities;  partly  in  the  technical  circumstances 
affecting  the  relative  demand  for  and  supply  of  these  several 
classes  of  goods ;  and  partly  in  the  adjusting  of  selling  prices 
to  changes  in  the  aggregate  of  buying  prices  which  a  business 
enterprise  pays,  rather  than  to  changes  in  the  prices  of  the 
particular  goods  bought  for  resale. 

In  the  great  majority  of  enterprises,  larger  profits  result 


656  CRISES 

from  these  divergent  price  fluctuations  coupled  with  the 
greater  physical  volume  of  sales.  For,  while  the  prices  of 
raw  materials  and  of  wares  bought  for  resale  usually,  and 
the  prices  of  bank  loans  often,  rise  faster  than  selling  prices, 
the  prices  of  labor  lag  far  behind,  and  the  prices  which 
make  up  supplementary  costs,  i.  e.,  interest,  rent,  depreciation, 
insurance,  salaries  for  general  officials  and  the  like,  are 
mainly  stereotyped  for  a  time  by  old  agreements  regarding 
salaries,  leases,  and  bonds. 

This  increase  of  profits,  combined  with  the  prevalence  of 
business  optimism,  leads  to  a  marked  expansion  of  invest- 
ments. Of  course  the  heavy  orders  for  machinery,  the  large 
contracts  for  new  construction,  etc.,  which  result,  swell  still 
further  the  physical  volume  of  business,  and  render  yet 
stronger  the  forces  which  are  driving  prices  upward. 

Indeed,  the  salient  characteristic  of  this  phase  of  the  busi- 
ness cycle  is  the  cumulative  working  of  the  various  processes 
which  are  converting  a  revival  of  trade  into  intense  pros- 
perity. Not  only  does  every  increase  in  the  physical  volume 
of  trade  cause  other  increases,  every  convert  to  optimism 
makes  new  converts,  and  every  advance  of  prices  furnishes 
an  incentive  for  fresh  advances;  but  the  growth  of  trade  also 
helps  to  spread  optimism  and  to  raise  prices,  while  optimism 
and  rising  prices  both  support  each  other  and  stimulate  the 
growth  of  trade.  Finally,  as  has  just  been  said,  the  changes 
going  forward  in  these  three  factors  swell  profits  and  en- 
courage investments,  while  high  profits  and  heavy  invest- 
ments react  by  augmenting  trade,  justifying  optimism,  and 
raising  prices. 

2.    HOW    PROSPERITY    BREEDS    A    CRISIS 

While  the  processes  just  sketched  work  cumulatively  for  a 
time  to  enhance  prosperity,  they  also  cause  a  slow  accumula- 
tion of  stresses  within  the  balanced  system  of  business  — 
stresses  which  ultimately  undermine  the  conditions  upon 
which  prosperity  rests. 

Among  these  stresses  is  the  gradual  increase  in  the  costs  of 
doing  business.  The  decline  in  supplementary  costs  per  unit 
of  output  ceases  when  enterprises  have  once  secured  all  the 


MITCHELL'S  ECLECTIC  THEORY  657 

business  they  can  handle  with  their  standard  equipment,  and 
a  slow  increase  of  these  costs  begins  when  the  expiration  of 
old  contracts  makes  necessary  renewals  at  the  high  rates  of 
interest,  rent,  and  salaries  which  prevail  in  prosperity. 
Meanwhile  prime  costs,  wages  and  raw  materials,  rise  at  a 
relatively  rapid  rate.  Equipment  which  is  antiquated  and 
plants  which  are  ill  located  or  otherwise  work  at  some  dis- 
advantage are  brought  again  into  operation.  The  price  of 
labor  rises,  not  only  because  standard  rates  of  wages  go 
up,  but  also  because  of  the  prevalence  of  higher  pay  for 
overtime.  More  serious  still  is  the  fact  that  the  efficiency  of 
labor  declines,  because  overtime  brings  weariness,  because 
of  the  employment  of  "  undesirables,"  and  because  crews 
cannot  be  driven  at  top  speed  when  jobs  are  more  numerous 
than  men  to  fill  them.  The  prices  of  raw  materials  continue 
to  rise  faster  on  the  average  than  the  selling  prices  of  products. 
Finally,  the  numerous  small  wastes,  incident  to  the  conduct 
of  business  enterprises,  creep  up  when  managers  are  hurried 
by  a  press  of  orders  demanding  prompt  delivery. 

A  second  stress  is  the  accumulating  tension  of  the  invest- 
ment and  money  markets.  The  supply  of  funds  available  at 
the  old  rates  of  interest  for  the  purchase  of  bonds,  for  lending 
on  mortgages,  and  the  like,  fails  to  keep  pace  with  the  rapidly 
swelling  demand.  It  becomes  difficult  to  negotiate  new  is- 
sues of  securities  except  on  onerous  terms,  and  men  of  affairs 
complain  of  the  "  scarcity  of  capital."  Nor  does  the  supply 
of  bank  loans  grow  fast  enough  to  keep  up  with  the  demand. 
For  the  supply  is  limited  by  the  reserves  which  bankers  hold 
against  their  expanding  demand  liabilities.  Full  employment 
and  active  retail  trade  cause  such  a  large  amount  of  money 
to  remain  suspended  in. active  circulation  that  the  cash  left 
in  the  banks  increases  rather  slowly,  even  when  the  gold  out-' 
put  is  rising  most  rapidly.  On  the  other  hand,  the  demand 
for  bank  loans  grows  not  only  with  the  physical  volume  of 
trade,  but  also  with  the  rise  of  prices,  and  with  the  desire 
of  men  of  affairs  to  use  their  own  funds  for  controlling  as 
many  business  ventures  as  possible.  Moreover,  this  demand 
is  relatively  inelastic,  since  many  borrowers  think  they  can 
pay  high  rates  of  discount  for  a  few  months  and  still  make 


658  CRISES 

profits  on  their  turnover,  and  since  the  corporations  which 
are  unwilling  to  sell  long-time  bonds  at  the  hard  terms  which 
have  come  to  prevail  try  to  raise  part  of  the  funds  they  re- 
quire by  discounting  one-  or  two-year  notes. 

Tension  in  the  bond  and  money  markets  is  unfavorable  to 
the  continuance  of  prosperity,  not  only  because  high  rates  of 
interest  reduce  the  prospective  margins  of  profit,  but  also 
because  they  check  the  expansion  in  the  volume  of  trade  out 
of  which  prosperity  developed.  Many  projected  ventures 
are  relinquished  or  postponed,  either  because  borrowers  con- 
clude that  the  interest  would  absorb  too  much  of  their  profits, 
or  because  lenders  refuse  to  extend  their  commitments  far- 
ther. 

There  is  one  important  group  of  enterprises  which  suffers 
an  especially  severe  check  from  this  cause  in  conjunction  with 
high  prices  —  the  group  which  depends  primarily  upon  the 
demand  for  industrial  equipment.  In  the  earlier  stages  of 
prosperity,  this  group  usually  enjoys  a  season  of  exception- 
ally intense  activity.  But  when  the  market  for  bonds  be- 
comes stringent,  and  —  what  is  often  more  important  — 
when  the  cost  of  construction  has  become  high,  business  en- 
terprises and  individual  capitalists  alike  defer  the  execution 
of  many  plans  for  extending  old  and  erecting  new  plants. 
As  a  result,  contracts  for  this  kind  of  work  become  less  nu- 
merous as  the  climax  of  prosperity  approaches.  Then  the 
steel  mills,  foundries,  machine  factories,  copper  smelters, 
quarries,  lumber  mills,  cement  plants,  construction  companies, 
general  contractors,  and  the  like  find  their  orders  for  future 
delivery  falling  off.  While  for  the  present  they  may  be  work- 
ing at  high  pressure  to  complete  old  contracts  within  the  stip- 
ulated time,  they  face  a  serious  restriction  of  trade  in  the 
'near  future. 

The  imposing  fabric  of  prosperity  is  built  with  a  liberal 
factor  of  safety ;  but  the  larger  grows  the  structure  the  more 
severe  become  these  internal  stresses.  The  only  effective 
means  of  preventing  disaster  while  continuing  to  build  is  to 
raise  selling  prices  time  after  time  high  enough  to  offset  the 
encroachments  of  costs  upon  profits,  to  cancel  the  advancing 


MITCHELL'S  ECLECTIC  THEORY  659 

rates  of  interest,  and  to  keep  investors  willing  to  contract  for 
fresh  industrial  equipment. 

But  it  is  impossible  to  keep  selling  prices  rising  for  an  in- 
definite time.  In  default  of  other  checks,  the  inadequacy  of 
cash  reserves  would  ultimately  compel  the  banks  to  refuse  a 
further  expansion  of  loans  upon  any  terms.  But  before  this 
stage  has  been  reached,  the  rise  of  prices  is  stopped  by  the 
consequences  of  its  own  inevitable  inequalities.  These  in- 
equalities become  more  glaring  the  higher  the  general  level 
is  forced;  after  a  time  they  threaten  serious  reduction  of 
profits  to  certain  business  enterprises,  and  the  troubles  of 
these  victims  dissolve  that  confidence  in  the  security  of  credits 
with  which  the  whole  towering  structure  of  prosperity  has 
been  cemented. 

What,  then,  are  the  lines  of  business  in  which  selling  prices 
cannot  be  raised  sufficiently  to  prevent  a  reduction  of  profits? 
There  are  certain  lines  in  which  selling  prices  are  stereotyped 
by  law,  by  public  commissions,  by  contracts  of  long  term,  by 
custom,  or  by  business  policy,  and  in  which  no  advance,  or 
but  meagre  advances  can  be  made.  There  are  other  lines  in 
which  prices  are  always  subject  to  the  incalculable  chances  of 
the  harvests,  and  in  which  the  market  value  of  all  accumu- 
lated, stocks  of  materials  and  finished  goods  wavers  with  the 
crop  reports.  There  are  always  some  lines  in  which  the  re- 
cent construction  of  new  equipment  has  increased  the  capacity 
for  production  faster  than  the  demand  for  their  wares  has 
expanded  under  the  repressing  influence  of  the  high  prices 
which  must  be  charged  to  prevent  a  reduction  of  profits. 
The  unwillingness  of  investors  to  let  fresh  contracts  threatens 
loss  not  only  to  contracting  firms  of  all  sorts,  but  also  to  all 
the  enterprises  from  whom  they  buy  materials  and  supplies. 
The  high  rates  of  interest  not  only  check  the  current  demand 
for  wares  of  various  kinds,  but  also  clog  the  effort  to  main- 
tain prices  by  keeping  large  stocks  of  goods  off  the  market 
until  they  can  be  sold  to  better  advantage.  Finally,  the  very 
success  of  other  enterprises  in  raising  selling  prices  fast 
enough  to  defend  their  profits  aggravates  the  difficulties  of 
the  men  who  are  in  trouble.  For  to  the  latter  every  further 


660  CRISES 

rise  of  prices  for  products  which  they  buy  means  a  further 
strain  upon  their  already  stretched  resources. 

As  prosperity  approaches  its  height,  then,  a  sharp  contrast 
develops  between  the  business  prospects  of  different  enter- 
prises. Many,  probably  the  majority,  are  making  more  money 
than  at  any  previous  stage  of  the  business  cycle.  But  an 
important  minority,  at  least,  face  the  prospect  of  declining 
profits.  The  more  intense  prosperity  becomes,  the  larger 
grows  this  threatened  group.  It  is  only  a  question  of  time 
when  these  conditions,  bred  by  prosperity,  will  force  some 
radical  readjustment. 

Now  such  a  decline  of  profits  threatens  worse  consequences 
than  the  failure  to  realize  expected  dividends.  For  it  arouses 
doubt  concerning  the  security  of  outstanding  credits.  Busi- 
ness credit  is  based  primarily  upon  the  capitalized  value  of 
present  and  prospective  profits,  and  the  volume  of  credits  out- 
standing at  the  zenith  of  prosperity  is  adjusted  to  the  great 
expectations  which  prevail  when  the  volume  of  trade  is  enor- 
mous, when  prices  are  high,  and  when  men  of  affairs  are 
optimistic.  The  rise  of  interest  rates  has  already  narrowed 
the  margins  of  security  behind  credits  by  reducing  the  capital- 
ized value  of  given  profits.  When  profits  themselves  begin 
to  waver  the  case  becomes  worse.  Cautious  creditors  fear 
lest  the  shrinkage  in  the  market  rating  of  the  business  enter- 
prises which  owe  them  money  will  leave  no  adequate  security 
for  repayment.  Hence  they  begin  to  refuse  renewals  of  old 
loans  to  the  enterprises  which  cannot  stave  off  a  decline  of 
profits,  and  to  press  for  a  settlement  of  outstanding  accounts. 

Thus  prosperity  ultimately  brings  on  conditions  which  start 
a  liquidation  of  the  huge  credits  which  it  has  piled  up.  And 
in  the  course  of  this  liquidation  prosperity  merges  into  crisis. 

3.    CRISES   AND   PANICS 

Once  begun,  the  process  of  liquidation  extends  rapidly, 
partly  because  most  enterprises  which  are  called  upon  to  settle 
their  maturing  obligations  in  turn  put  similar  pressure  upon 
their  own  debtors,  and  partly  because,  despite  all  efforts  to 
keep  secret  what  is  going  forward,  news  presently  leaks  out 
and  other  creditors  take  alarm. 


MITCHELL'S  ECLECTIC  THEORY  66l 

While  this  financial  readjustment  is  under  way,  the  problem 
of  making  profits  on  current  transactions  is  subordinated  to 
the  more  vital  problem  of  maintaining  solvency.  Business 
managers  concentrate  their  energies  upon  providing  for  their 
outstanding  liabilities  and  upon  nursing  their  financial  re- 
sources, instead  of  upon  pushing  their  sales.  In  consequence, 
the  volume  of  new  orders  falls  off  rapidly.  That  is,  the 
factors  which  were  already  dimming  the  prospects  of  profits 
in  certain  lines  of  business  are  reinforced  and  extended. 
Even  when  the  overwhelming  majority  of  enterprises  meet 
the  demand  for  payment  with  success,  the  tenor  of  business 
developments  therefore  undergoes  a  change.  Expansion  gives 
place  to  contraction,  though  without  a  violent  wrench.  Dis- 
count rates  rise  higher  than  usual,  securities  and  commodities 
fall  in  price,  and  as  old  orders  are  completed  working  forces 
are  reduced;  but  there  is  no  epidemic  of  bankruptcies,  no  run 
upon  banks,  and  no  spasmodic  interruption  of  the  ordinary 
business  processes. 

At  the -opposite  extreme  from  crises  of  this  mild  order  stand 
the  crises  which  degenerate  into  panics.  When  the  process 
of  liquidation  reaches  a  weak  link  in  the  chain  of  interlocking 
credits  and  the  bankruptcy  of  some  conspicuous  enterprise 
spreads  unreasoning  alarm  among  the  business  public,  then 
the  banks  are  suddenly  forced  to  meet  a  double  strain  —  a 
sharp  increase  in  the  demand  for  loans,  and  a  sharp  increase 
in  the  demand  for  repayment  of  deposits.  If  the  banks  prove 
able  to  honor  both  demands  without  flinching,  the  alarm 
quickly  subsides.  But  if,  as  has  happened  twice  in  America 
since  1890,  many  solvent  business  men  are  refused  accommo- 
dation at  any  price,  and  if  depositors  are  refused  payment  in 
full,  the  alarm  turns  into  panic.  A  restriction  of  payments 
by  the  banks  gives  rise  to  a  premium  upon  currency,  to  hoard- 
ing of  cash,  and  to  the  use  of  various  unlawful  substitutes  for 
money.  A  refusal  by  the  banks  to  expand  their  loans,  still 
more  a  policy  of  contraction,  sends  interest  rates  up  to  three 
or  four  times  their  usual  figures,  and  causes  forced  suspen- 
sions and  bankruptcies.  There  follow  appeals  to  the  Govern- 
ment for  extraordinary  aid,  frantic  efforts  to  import  gold, 
the  issue  of  clearing-house  loan  certificates,  and  an  increase 


662  CRISES 

of  bank-note  circulation  as  rapid  as  the  existing  system  per- 
mits. Collections  fall  into  arrears,  domestic-exchange  rates 
are  dislocated,  workmen  are  discharged  because  employers 
cannot  get  money  for  pay-rolls  or  fear  lest  they  cannot  get 
pay  for  goods  when  delivered,  stocks  fall  to  extremely  low 
levels,  even  the  best  bonds  decline  somewhat  in  price,  com- 
modity markets  are  disorganized  by  sacrifice  sales,  and  the 
volume  of  business  is  violently  contracted. 

That  crises  still  degenerate  on  occasion  into  panics  in 
America,  but  not  in  England,  France,  or  Germany,  arises  pri- 
marily from  differences  in  banking  organization  and  practice. 
In  each  of  the  three  European  countries,  the  banking  system 
as  a  whole  is  so  organized  by  the  prevalence  of  branch  bank- 
ing and  the  existence  of  a  central  bank  that  reserves  which 
bear  a  small  proportion  to  the  aggregate  demand  liabilities 
of  all  the  offices  can  be  applied  when  and  where  they  are  most 
needed.  The  central  bank  not  only  carries  a  reserve  which 
is  far  in  excess  of  immediate  requirements  in  ordinary  times, 
but  also  uses  this  reserve  boldly  in  times  of  stress,  presenting 
in  both  these  respects  a  marked  contrast  to  the  policy  of 
American  banks.  As  a  result,  European  business  men  need 
not  fear  either  a  refusal  to  lend  or  a  restriction  of  payments 
by  the  banks  on  which  they  depend.  And  panic  has  small 
chance  to  develop  where  the  depositor  can  get  his  money  at 
need  and  the  solvent  business  man  can  borrow.  [Written 
before  the  establishment  of  the  Federal  Reserve  system.] 

4.  DEPRESSION 

The  close  of  a  panic  is  usually  followed  by  the  reopening 
of  numerous  enterprises  which  had  been  shut  during  the  weeks 
of  severest  pressure.  But  this  prompt  revival  of  activity  is 
partial  and  short-lived.  It  is  based  chiefly  upon  the  finishing 
of  orders  received  but  not  completely  executed  in  the  preced- 
ing period  of  prosperity,  or  upon  the  effort  to  work  up  and 
market  large  stocks  of  materials  already  on  hand  or  con- 
tracted for.  It  comes  to  an  end  as  this  work  is  gradually 
finished,  because  new  orders  are  not  forthcoming  in  sufficient 
volume  to  keep  the  mills  and  factories  busy. 

There  follows  a  period  during  which  depression  spreads 


MITCHELL'S  ECLECTIC  THEORY  663 

over  the  whole  field  of  business  and  grows  more  severe. 
Consumers'  demand  declines  in  consequence  of  wholesale  dis- 
charges of  wage-earners,  the  gradual  exhaustion  of  past  sav- 
ings, and  the  reduction  of  other  classes  of  family  incomes. 
With  consumers'  demand  falls  the  business  demand  for  raw 
materials,  current  supplies,  and  equipment  used  in  making 
consumers'  goods.  Still  more  severe  is  the  shrinkage  of  in- 
vestors' demand  for  construction  work  of  all  kinds,  since  few 
individuals  or  enterprises  care  to  sink  money  in  new  business 
ventures  so  long  as  trade  remains  depressed  and  the  price 
level  is  declining.  The  contraction  in  the  physical  volume  of 
business  which  results  from  these  several  shrinkages  in  de- 
mand is  cumulative,  since  every  reduction  of  employment 
causes  a  reduction  of  consumers'  demand,  and  every  decline 
in  consumers'  demand  depresses  current  business  demand 
and  discourages  investment,  thereby  causing  further  dis- 
charges of  employes  and  reducing  consumers'  demand  once 
more. 

With  the  contraction  in  the  physical  volume  of  trade  goes 
a  fall  of  prices.  For,  when  current  orders  are  insufficient 
to  employ  the  existing  equipment  for  production,  competition 
for  what  business  is  to  be  had  becomes  keener.  This  decline 
spreads  through  the  regular  commercial  channels  which  con- 
nect one  enterprise  with  another,  and  is  cumulative,  since 
every  reduction  in  price  facilitates,  if  it  does  not  force,  reduc- 
tions in  other  prices,  and  the  latter  reductions  react  in  their 
turn  to  cause  fresh  reductions  at  the  starting  point. 

As  the  rise  of  prices  which  accompanied  revival,  so  the  fall 
which  accompanies  depression  is  characterized  by  certain 
regularly  recurring  differences  in  degree.  Wholesale  prices 
fall  faster  than  retail,  the  prices  of  producers'  goods  faster 
than  those  of  consumers'  goods,  and  the  prices  of  raw  ma- 
terials faster  than  those  of  manufactured  products.  The 
prices  of  raw  mineral  products  follow  a  more  regular  course 
than  those  of  raw  forest,  farm,  or  animal  products.  As  com- 
pared with  general  index  numbers  of  commodity  prices  at 
wholesale,  index  numbers  of  wages  and  interest  on  long-time 
loans  decline  in  less  degree,  while  index  numbers  of  discount 
rates  and  of  stocks  decline  in  greater  degree.  The  only  im- 


664  CRISES 

portant  group  of  prices  to  rise  in  the  face  of  depression  is 
that  of  high-grade  bonds. 

Of  course  the  contraction  in  the  physical  volume  of  trade 
and  the  fall  of  prices  reduce  the  margin  of  present  and  pros- 
pective profits,  spread  discouragement  among  business  men, 
and  check  enterprise.  But  they  also  set  in  motion  certain 
processes  of  readjustment  by  which  depression  is  gradually 
overcome. 

The  prime  costs  of  doing  business  are  reduced  by  the  rapid 
fall  in  the  prices  of  raw  materials  and  of  bank  loans,  by  the 
marked  increase  in  the  efficiency  of  labor  which  comes  when 
employment  is  scarce  and  men  are  anxious  to  hold  their  jobs, 
and  by  close  economy  on  the  part  of  managers.  Supplemen- 
tary costs  also  are  reduced  by  reorganizing  enterprises  which 
have  actually  become  or  which  threaten  to  become  insolvent, 
by  the  sale  of  other  enterprises  at  low  figures,  by  reduction 
of  rentals  and  refunding  of  loans,  by  charging  off  bad  debts 
and  writing  down  depreciated  properties,  and  by  admitting 
that  a  recapitalization  of  business  enterprises  —  correspond- 
ing to  the  lower  prices  of  stocks  —  has  been  effected  on  the 
basis  of  lower  profits. 

While  these  reductions  in  costs  are  still  being  made,  the 
demand  for  goods  ceases  to  shrink  and  then  begins  slowly  to 
expand  —  a  change  which  usually  comes  in  the  second  or  third 
year  of  depression.  Accumulated  stocks  left  over  from 
prosperity  are  gradually  exhausted,  and  current  consumption 
requires  current  production.  Clothing,  furniture,  machinery 
and  other  moderately  durable  articles  which  have  been  used 
as  long  as  possible  are  finally  discarded  and  replaced.  Popu- 
lation continues  to  increase  at  a  fairly  uniform  rate:  the  new 
mouths  must  be  fed  and  the  new  backs  clothed.  New  tastes 
appear  among  consumers  and  new  methods  among  producers, 
giving  rise  to  demand  for  novel  products.  Most  important 
of  all,  the  investment  demand  for  industrial  equipment  re- 
vives ;  for  though  saving  may  slacken  it  does  not  cease,  with 
the  cessation  of  foreclosure  sales  and  corporate  reorganiza- 
tions the  opportunities  to  buy  into  old  enterprises  at  bargain 
prices  become  fewer,  capitalists  become  less  timid  as  the  crisis 
recedes  into  the  past,  the  low  rates  of  interest  on  long-term 


MOORE'S  "RAINFALL"  THEORY  665 

bonds  encourage  borrowing,  the  accumulated  technical  im- 
provements of  several  years  may  be  utilized,  and  contracts 
can  be  let  on  most  favorable  conditions  as  to  cost  and  prompt 
execution. 

Once  tb-^se  various  forces  have  set  the  physical  volume  of 
trade  to  expanding  again,  the  increase  proves  cumulative, 
though  for  a  time  the  pace  of  growth  is  kept  slow  by  the  con- 
tinued sagging  of  prices.  But  while  the  latter  maintains  the 
pressure  upon  business  men  and  prevents  the  increased  volume 
of  orders  from  producing  a  rapid  rise  of  profits,  still  business 
prospects  become  gradually  brighter.  Old  debts  have  been 
paid,  accumulated  stocks  of  commodities  have  been  absorbed, 
weak  enterprises  have  been  reorganized,  the  banks  are  strong 

—  all  the  clouds  upon  the  financial  horizon  have  disappeared. 
Everything  is  ready  for  a  revival  of  activity,  which  will  begin 
whenever  some  fortunate  circumstance  gives  a  sudden  fillip  to 
demand,  or,  in  the  absence  of  such  an  event,  when  the  slow 
growth  of  the  volume  of  business  has  filled  order  books  and 
paved  the  way  for  a  new  rise  of  prices.     Such  is  the  stage  of 
the  business  cycle  with  which  the  analysis  began,  and,  having 
accounted  for  its  own  beginning,  the  analysis  ends. 

MOORE'S  "  RAINFALL  "  THEORY 

1  To  Professor  Moore  the  fundamental  problem  of  eco- 
nomic dynamics  is  to  formulate  the  law  governing  the  "  ebb 
and  flow  of  economic  life  "  which  is  "  the  most  general  and 
characteristic  phenomenon  of  a  changing  society."  The 
motto  of  the  department  of  agriculture  of  the  United  States 

—  "  Agriculture  is  the  foundation  of  manufacture  and  com- 
merce "  —  is  significant  and  that  the  farmer  is  at  the  mercy 
of  the  weather  is  proverbial.     There  may  be  such  a  close  con- 
nection between  the  weather,  the  crops,  and  crises  that  we  shall 
be  able  to  find  in  weather  changes  the  cause  of  crises. 

An  examination  of  all  the  numerous  factors  involved  in 
the  problem  would  be  a  stupendous  task  and  Professor  Moore 
limits  himself  to  a  consideration  of  a  selected  few.  '  The 
variation  in  the  quantity  of  the  rainfall  is  one  of  the  weather 

*E.  M.  Patterson,  The  Theories  Advanced  in  Explanation  of  Economic 
Crises.  Annals  of  American  Academy  of  Political  and  Social  Science, 
Vol.  59,  May,  1915,  pp.  140,  141,  147. 


666  CRISES 

changes  known  to  have  a  marked  effect  upon  the  yield  of 
the  crops."  Hence  the  inquiry  is  directed  to  an  examination 
of  the  "  appropriate  data  with  reference  to  three  things  :  ( I ) 
the  periodicity  of  rainfall;  (2)  the  effect  of  rainfall  on  the 
crops;  (3)  the  relation  of  the  yield  of  the  crops  to  economic 
cycles."  The  study  is  a  statistical  one  conducted  with  the 
greatest  of  care  to  avoid  error  and  the  conclusions  are  de- 
serving of  the  most  careful  consideration.  All  generalizations 
are  made  carefully  and  used  cautiously  with  a  full  realization 
that  a  limited  area  —  the  upper  Mississippi  Valley  —  has 
been  used  and  a  period  of  only  seventy-two  years  surveyed. 
Of  the  numerous  climatic  factors  only  rainfall  has  been  ex- 
amined. 

Remembering  that  these  limitations  are  fully  realized  we 
may  state  the  conclusions  in  Professor  Moore's  own  words : 
"  The  fundamental,  persistent  cause  of  the  cycles  in  the  yield 
of  the  crops  is  the  cyclical  movement  in  the  weather  condi- 
tions represented  by  the  rhythmically  changing  amount  of 
rainfall;  the  cyclical  movement  in  the  yield  of  the  crops  is  the 
fundamental,  persistent  cause  of  economic  cycles."  This 
should  be  supplemented  with  a  statement  of  the  law  that  has 
been  sought  and  which  may  be  formulated  thus : 

The  weather  conditions  represented  by  the  rainfall  in  the  central 
part  of  the  United  States,  and  probably  in  other  continental  areas, 
pass  through  cycles  of  approximately  thirty-three  years  and  eight 
years  in  duration,  causing  like  cycles  in  the  yield  per  acre  of  the 
crops;  these  cycles  of  crops  constitute  the  natural,  material  current 
which  drags  upon  its  surface  the  lagging,  rhythmically  changing 
values  and  prices  with  which  the  economist  is  more  immediately 
concerned.  .  .  . 

In  conclusion  we  may  merely  observe  that  many  theories 
are  obviously  presented  to  defend  some  of  the  other  views 
of  their  advocates.  The  connection  of  the  socialist  theory 
with  the  socialistic  idea  of  value  is  an  obvious  one.  It  may 
also  be  true  that  interest  in  some  particular  phase  of  study 
may  cause  the  investigator  to  overlook  the  importance  of 
other  elements  in  the  problem.  Thus  to  Professor  Moore 
climatic  conditions  seem  of  great  importance,  while  Professor 
Mitchell  relegates  them  to  a  very  minor  position.  As  time 


HOW  BANKS  SHOULD  HANDLE  PANICS  667 

passes  it  will  doubtless  be  possible  to  estimate  the  significance 
of  each  factor  with  more  accuracy.  When  this  is  done  a 
more  satisfactory  theory  can  be  formulated  and  methods  of 
prevention  and  alleviation  employed  to  better  advantage. 

STRINGENT  MONEY  AND  FINANCIAL  PANICS  1 

Is  there  any  tendency  for  financial  panics  to  occur  more 
frequently  in  the  seasons  of  the  year  when  the  money  market 
is  normally  stringent?  It  has  been  found  that  the  two 
periods  of  the  year  in  which  the  money  market  is  most  likely 
to  be  strained  are  the  periods  of  the  spring  trade  revival 
(about  March  and  April)  and  that  of  the  crop-moving  demand 
in  the  fall;  and  that  the  two  periods  of  the  easiest  money 
market  are  the  "  readjustment  period,"  extending  from  about 
the  middle  of  January  to  about  the  first  of  March,  and  the 
period  of  the  summer  depression,  extending  through  the  sum- 
mer months.  Of  the  eight  panics  which  have  occurred  since 
1873,  four  occurred  in  the  fall  or  early  winter  (/.  e.,  those  of 
1873,  1890,  1899,  and  1907)  ;  and  one  (i.  e.,  that  of  1903) 
extended  from  March  until  well  along  in  November.  Out  of 
a  total  of  twenty-one  minor  panics  or  "  panicky  periods  " 
occurring  between  1876  and  1908,  inclusive,  nine  occurred 
during  the  fall  and  early  winter,  eight  during  the  spring,  one 
began  in  May  and  extended  into  June,  three  occurred  during 
the  summer  months,  and  one  occurred  in  February.  The 
evidence  accordingly  points  to  a  tendency  for  the  panics  to 
occur  during  the  seasons  normally  characterized  by  a  stringent 
money  market. 

How  BANKS  SHOULD  HANDLE  PANICS 

2  Whatever  persons  —  one  bank  or  many  banks  —  in  any 
country  hold  the  banking  reserve  of  that  country,  ought  at 
the  very  beginning  of  an  unfavourable  foreign  exchange  at 

*£.  W.  Kemmerer,  Seasonal  Variations  .in  the  Relative  Demand  for 
Currency  and  Capital  in  the  United  States,  p.  232.  Publications  of  the 
National  Monetary  Commission,  Senate  Document  No.  588,  6ist  Congress, 
2d  Session. 

2  Walter  Bagehot,  Lombard  Street,  pp.  46-56.  Charles  Scribner's  Sons. 
New  York.  1892.  (First  Edition,  1873.) 


668  CRISES 

once  to  raise  the  rate  of  interest,  so  as  to  prevent  their  reserve 
from  being  diminished  farther,  and  so  as  to  replenish  it  by 
imports  of  bullion.  .  .  . 

A  domestic  drain  is  very  different.  Such  a  drain  arises 
from  a  disturbance  of  credit  within  the  country,  and  the 
difficulty  of  dealing  with  it  is  the  greater,  because  it  is  often 
caused,  or  at  least  often  enhanced,  by  a  foreign  drain.  Times 
without  number  the  public  have  been  alarmed  mainly  because 
they  saw  that  the  banking  reserve  was  already  low,  and  that 
it  was  daily  getting  lower.  The  two  maladies  —  an  external 
drain  and  an  internal  —  often  attack  the  money  market  at 
once.  What  then  ought  to  be  done? 

In  opposition  to  what  might  be  at  first  sight  supposed,  the 
best  way  for  the  bank  or  banks  who  have  the  custody  of  the 
bank  reserve  to  deal  with  a  drain  arising  from  internal  dis- 
credit, is  to  lend  freely.  The  first  instinct  of  every  one  is  the 
contrary.  There  being  a  large  demand  on  a  fund  which  you 
want  to  preserve,  the  most  obvious  way  to  preserve  it  is  to 
hoard  it  —  to  get  in  as  much  as  you  can,  and  to  let  nothing 
go  out  which  you  can  help.  But  every  banker  knows  that  this 
is  not  the  way  to  diminish  discredit.  This  discredit  means, 
"  an  opinion  that  you  have  not  got  any  money,"  and  to  dissi- 
pate that  opinion,  you  must,  if  possible,  show  that  you  have 
money :  you  must  employ  it  for  the  public  benefit  in  order 
that  the  public  may  know  that  you  have  it.  The  time  for 
economy  and  for  accumulation  is  before.  A  good  banker 
will  have  accumulated  in  ordinary  times  the  reserve  he  is  to 
make  use  of  in  extraordinary  times. 

Ordinarily  discredit  does  not  at  first  settle  on  any  particular 
bank,  still  less  does  it  at  first  concentrate  itself  on  the  bank 
or  banks  holding  the  principal  cash  reserve.  These  banks 
are  almost  sure  to  be  those  in  best  credit,  or  they  would  not 
be  in  that  position,  and,  having  the  reserve,  they  are  likely  to 
look  stronger  and  seem  stronger  than  any  others.  At  first, 
incipient  panic  amounts  to  a  kind  of  vague  conversation :  Is 
A  B  as  good  as  he  used  to  be?  Has  not  C  D  lost  money? 
and  a  thousand  such  questions.  A  hundred  people  are  talked 
about,  and  a  thousand  think — "Am  I  talked  about,  or  am  I 
not?  "  "  Is  my  credit  as  good  as  it  used  to  be,  or  is  it  less?  " 


HOW  BANKS  SHOULD  HANDLE  PANICS  669 

And  every  day,  as  a  panic  grows,  this  floating  suspicion  be- 
comes both  more  intense  and  more  diffused;  it  attacks  more 
persons,  and  attacks  them  all  more  virulently  than  at  first.  All 
men  of  experience,  therefore,  try  to  "  strengthen  themselves," 
as  it  is  called,  in  the  early  stage  of  a  panic ;  they  borrow  money 
while  they  can;  they  come  to  their  banker  and  offer  bills 
for  discount,  which  commonly  they  would  not  have  offered 
for  days  or  weeks  to  come.  And  if  the  merchant  be  a  regular 
customer,  a  banker  does  not  like  to  refuse,  because  if  he  does 
he  will  be  said,  or  may  be  said,  to  be  in  want  of  money,  and 
so  may  attract  the  panic  to  himself.  Not  only  merchants  but 
all  persons  under  pecuniary  liabilities  —  present  or  imminent 
—  feel  this  wish  to  "  strengthen  themselves,"  and  in  propor- 
tion to  those  liabilities.  .  .  . 

A  panic,  in  a  word,  is  a  species  of  neuralgia,  and  according 
to  the  rules  of  science  you  must  not  starve  it.  The  holders  of 
the  cash  reserve  must  be  ready  not  only  to  keep  it  for  their  own 
liabilities,  but  to  advance  it  most  freely  for  the  liabilities  of 
others.  They  must  lend  to  merchants,  to  minor  bankers,  to 
"  this  man  and  that  man,"  whenever  the  security  is  good.  In 
wild  periods  of  alarm,  one  failure  makes  many,  and  the  best 
way  to  prevent  the  derivative  failures  is  to  arrest  the  primary 
failure  which  causes  them.  The  way  in  which  the  panic  of 
1825  was  stopped  by  advancing  money  has  been  described  in 
so  broad  and  graphic  a  way  that  the  passage  has  become 
classical.  "  We  lent  it,"  said  Mr.  Harmon,  on  behalf  of  the 
Bank  of  England,  "  by  every  possible  means  and  in  modes 
we  had  never  adopted  before;  we  took  in  stock  on  security, 
we  purchased  Exchequer  bills,  we  made  advances  on  Ex- 
chequer bills,  we  not  only  discounted  outright,  but  we  made 
advances  on  the  deposit  of  bills  of  exchange  to  an  immense 
amount,  in  short,  by  every  possible  means  consistent  with  the 
safety  of  the  bank,  and  we  were  not  on  some  occasions  over- 
nice.  Seeing  the  dreadful  state  in  which  the  public  were,  we 
rendered  every  assistance  in  our  power."  After  a  day  or 
two  of  this  treatment,  the  entire  panic  subsided,  and  the 
"  City  "  was  quite  calm. 

The  problem  of  managing  a  panic  must  not  be  thought  of 
as  mainly  a  "  banking  "  problem.  It  is  primarily  a  mercan- 


670  CRISES 

tile  one.  All  merchants  are  under  liabilities;  they  have  bills 
to  meet  soon,  .  .  .  are  dependent  on  borrowing  money,  and 
large  merchants  are  dependent  on  borrowing  much  money. 
At  the  slightest  symptom  of  panic  many  merchants  want  to 
borrowr  more  than  usual;  they  think  they  will  supply  them- 
selves with  the  means  of  meeting  their  bills  while  those  means 
are  still  forthcoming.  If  the  bankers  gratify  the  merchants, 
they  must  lend  largely  just  when  they  like  it  least;  if  they 
do  not  gratify  them,  there  is  a  panic. 

On  the  surface  there  seems  a  great  inconsistency  in  all  this. 
First,  you  establish  in  some  bank  or  banks  a  certain  reserve; 
you  make  of  it  or  them  a  kind  of  ultimate  treasury,  where 
the  last  shilling  of  the  country  is  deposited  and  kept.  And 
then  you  go  on  to  say  that  this  final  treasury  is  also  to  be  the 
last  lending-house ;  that  out  of  it  unbounded,  or  at  any  rate 
immense,  advances  are  to  be  made  when  no  one  else  lends. 
This  seems  like  saying  —  first,  that  the  reserve  should  be 
kept,  and  then  that  it  should  not  be  kept.  But  there  is  no 
puzzle  in  the  matter.  The  ultimate  banking  reserve  of  a 
country  (by  whomsoever  kept)  is  not  kept  out  of  show,  but 
for  certain  essential  purposes,  and  one  of  those  purposes  is 
the  meeting  of  a  demand  for  cash  caused  by  an  alarm  within 
the  country.  It  is  not  unreasonable  that  our  ultimate  treas- 
ure in  particular  cases  should  be  lent;  on  the  contrary,  we 
keep  that  treasure  for  the  very  reason  that  in  particular  cases 
it  should  be  lent. 

When  reduced  to  abstract  principle,  the  subject  comes  to 
this.  An  "  alarm  "  is  an  opinion  that  the  money  of  certain 
persons  will  not  pay  their  creditors  when  those  creditors  want 
to  be  paid.  If  possible,  that  alarm  is  best  met  by  enabling 
those  persons  to  pay  their  creditors  to  the  very  moment.  For 
this  purpose  only  a  little  money  is  wanted.  If  that  alarm  is 
not  so  met,  it  aggravates  into  a  panic,  which  is  an  opinion  that 
most  people,  or  very  many  people,  will  not  pay  their  credit- 
ors; and  this  too  can  only  be  met  by  enabling  all  those  per- 
sons to  pay  what  they  owe,  which  takes  a  great  deal  of  money. 
No  one  has  enough  money,  or  anything  like  enough,  but  the 
holders  of  the  bank  reserve.  .  .  . 

.  .  .  Before  1844,  an  issue  of  notes  [of  the  Bank  of  Eng- 


HOW  BANKS  SHOULD  HANDLE  PANICS  671 

land],  as  in  1825,  to  quell  a  panic  entirely  internal  did  not 
diminish  the  bullion  reserve.  The  notes  went  out,  but  they 
did  not  return.  They  were  issued  as  loans  to  the  public,  but 
the  public  wanted  no  more ;  they  never  presented  them  for  pay- 
ment; they  never  asked  that  sovereigns  should  be  given  for 
them.  But  the  acceptance  of  a  great  liability  during  an  aug- 
menting alarm,  though  not  as  bad  as  an  equal  advance  of 
cash,  [/.  e.,  specie]  is  the  thing  next  worst.  At  any  moment 
the  cash  may  be  demanded.  Supposing  the  panic  to  grow, 
it  will  be  demanded,  and  the  reserve  will  be  lessened  accord- 
ingly. .  .  . 

"  On  extraordinary  occasions,"  says  Ricardo,  "  a  general 
panic  may  seize  the  country,  when  every  one  becomes  desirous 
of  possessing  himself  of  the  precious  metals  as  the  most  con- 
venient mode  of  realizing  or  concealing  his  property  — 
against  such  panic  banks  have  no  security  on  any  system." 
The  bank  or  banks  which  hold  the  reserve  may  last  a  little 
longer  than  the  others;  but  if  apprehension  pass  a  certain 
bound,  they  must  perish  too.  The  use  of  credit  is,  that  it 
enables  debtors  to  use  a  certain  part  of  the  money  their  credit- 
ors have  lent  them.  If  all  those  creditors  demand  all  that 
money  at  once,  they  cannot  have  it,  for  that  which  their 
debtors  have  used,  is  for  the  time  employed,  and  not  to  be 
obtained.  With  the  advantages  of  credit  we  must  take  the 
disadvantages,  too;  but  to  lessen  them  as  much  as  we  can, 
we  must  keep  a  great  store  of  ready  money  always  available, 
and  advance  out  of  it  very  freely  in  periods  of  panic,  and  in 
times  of  incipient  alarm. 


CHAPTER  XXX 

THE  WEAKNESSES  OF  OUR  BANKING  SYSTEM 

PRIOR  TO  THE  ESTABLISHMENT  OF  THE 

FEDERAL  RESERVE  SYSTEM 

CONFLICTING  OPINIONS 

1  FOR  fifty  years  the  United  States  has  lived  rather  happily 
under  the  National  Bank  Act,  born  in  the  strife  of  the  Civil 
War  and  developed  in  the  period  of  the  nation's  greatest  ex- 
pansion and  growth.  This  act  has,  by  its  record,  earned 
for  itself  a  place  as  a  great  piece  of  constructive  legislation ; 
and  the  recognition  of  this  fact  is  responsible  for  the  preserva- 
tion of  our  national  banking  system  almost  intact  under  the 
Federal  Reserve  Act.  The  National  Bank  Act  removed  the 
ills  of  wildcat  banking,  which  so  afflicted  the  country  prior 
to  the  Civil  War;  gave  us  an  absolutely  safe  form  of  money 
which,  although  not  legal  tender,  is  taken  without  question 
by  everyone;  and  has  made  possible  an  enormous  expansion 
in  the  banking  resources  and  facilities  of  the  country.  In 
spite  of  the  denunciation  and  abuse  which  have  been  heaped 
upon  it,  the  act  has  been  reasonably  satisfactory  in  operation. 
Anyone  who  reviews  the  figures  of  the  material  growth  and 
prosperity  of  the  nation  and  the  rise  of  its  financial  power 
will  be  forced  to  the  conclusion  that  no  act  that  was  funda- 
mentally unsound  could  have  been  an  integral  part  of  the 
achievement  of  such  a  notable  record. 

Designed  for  the  purpose  of  encouraging  a  system  of  in- 
dependent banks,  the  act  has  been  responsible,  directly  and 
indirectly,  for  the  creation  of  some  twenty-five  thousand 
banking  institutions  in  this  country,  practically  all  of  which 

1  Conway  and  Patterson,  The  Operation  of  the  New  Bank  Act,  pp.  I,  2. 
J.  B.  Lippincott  Company,  Philadelphia,  1914. 

672 


CONFLICTING  OPINIONS  673 

are  independent  of  each  other.  Instead  of  a  small  banking 
class  and  an  equally  small  group  of  banks,  all  under  the 
domination  of  one  or  a  very  few  interests,  we  have  developed 
a  system  of  banking  which  has  sprung  from  the  people,  and 
which  is  closer  to  the  people  than  that  of  any  other  country. 

1  We  have  grown  and  prospered  in  spite  of  an  imperfect, 
repressing,  and  perilous  banking  and  currency  system.     We 
have  grown  as  a  vine  sometimes  forces  its  way  through  a 
crevice  in  a  wall,  our  very  growth  inviting  disaster  and  death, 
our  wonderful  vitality  hastening  catastrophe.  .  .  .  Over  fifty 
years  of  growth  under  the  old  banking  act  has  been  forced 
by  the  generosity  of  the  soil  of  a  new  land,  by  the  unconquer- 
able energy  and  resiliency  of  a  virile  and  courageous  people; 
yet  it  has  been  interrupted  by  periods  of  business  depression 
and  stagnation;  our  progress  punctuated  by  panics,  discredit- 
able, appalling  —  to  many  ruinous.  .  .  .  The  immediate  re- 
sults .  .  .  have  been  crashing  of  banks  and  commercial  houses, 
the  wholesale  stoppage  of  industries,  the  wiping  away  or  cruel 
draining  of  the  results  of  honest  thrift,  denial  to  willing  and 
hungry  labor  of  the  opportunity  to  earn  bread  and  shelter. 

2  A  physician  would  probably  say  that  what  primarily  ails 
our  currency  system  and  causes  panics  and  desperate  stringen- 
cies  is   something  akin  to  arteriosclerosis.     The  veins  and 
arteries  of  credit,  which  in  order  to  function  properly  ought 
to  be  elastic  and  contractile  like  rubber,  are  hard  and  brittle 
as  glass.     When  subjected  to  unusual  strain  they  can  yield 
but  little  and   are   very   liable  to   rupture,   and   when   once 
stretched  they  are  apt  to  remain  over-enlarged.  .  .  . 

The  temporary  act  of  May  30,  1908,  which  relaxed  the 
rigor  of  the  law  in  moments  of  critical  emergency  [as  to 
note  issues]  by  permitting  additions  to  the  currency  to  be 

ijohn  Skelton  Williams,  Comptroller  of  the  Currency,  Democracy  in 
Banking,  Address  delivered  before  the  annual  convention  of  the  North 
Carolina  Bankers'  Association,  Raleigh,  May  13,  IQM-  Printed  in  Con- 
gressional Record,  63d  Congress.  2d  Session,  Vol.  51,  pp.  10150-53. 

2  A.  Piatt  Andrew,  The  Essential  and  the  Unessential  in  Currency  Legis- 
lation, in  Questions  of  Public  Policy,  Addresses  delivered  in  the  Page  Lec- 
ture Series,  1913,  before  the  Senior  Class  of  the  Sheffield  Scientific  School, 
Yale  University,  pp.  62-70.  Yale  University  Press,  New  Haven,  Connecti- 
cut, 1913. 


674  DEFECTS  OF  OUR  BANKING  SYSTEM 

based  upon  other  security  by  payment  of  a  heavy  and  increas- 
ing tax,  was  no  real  solution  of  the  situation.  It  contained 
no  provision  to  render  the  currency  responsive  to  ordinary 
fluctuations  in  currency  demand,  and  resort  to  its  provisions 
in  times  of  great  stress  might  easily  precipitate  a  panic  if  one 
did  not  already  exist.  It  was  only  enacted  for  six  years,  and 
was  only  regarded  by  its  sponsors  as  a  temporary  palliative 
pending  the  preparation  of  a  permanent  cure.  One  uni- 
versally recognized  essential  .  .  .  of  a  proper  banking  and 
currency  plan  is  provision  for  a  more  flexible  and  responsive 
note  issue. 

INFLEXIBILITY  OF  LEDGER  BALANCES 

When  we  turn  to  credit  in  the  form  of  ledger  balances  or 
"  deposits  "  and  enquire  as  to  the  causes  of  their  inflexibility, 
the  explanation  also  rests  in  quite  familiar  facts.  There  are 
two  peculiar  features  of  our  banking  system  which  are  prac- 
tically without  counterpart  in  other  important  countries,  and 
which  render  ledger  balances  or  deposit  credits  in  this  country 
less  flexible  and  responsive  than  such  balances  or  credits  are 
elsewhere.  The  first  is  the  rigidity  of  our  reserve  laws,  and 
the  second  is  the  lack  of  any  bankers'  bank  or  similar  institu- 
tion, with  ample  resources  and  lending  power,  from  which 
the  banks  can  replenish  their  own  reserves  when  necessary. 

RIGID   RESERVE   REQUIREMENTS 

Outside  of  the  United  States  I  know  of  only  one  other 
country  in  which  the  law  requires  a  cash  reserve  to  be  held 
against  deposits.  That  country  is  Holland,  and  the  law  ap- 
plies to  only  one  institution,  the  Bank  of  the  Netherlands, 
and  that  institution  does  not  hold  enough  deposits  to  make  it 
worth  mentioning  in  this  connection  (less  than  $3,000,000). 
Our  national  banking  law,  however,  and  the  banking  laws  of 
most  of  the  states  are  unreasonably  and  unsoundly  rigorous 
in  this  regard.  Not  only  must  stated  proportions  of  all  de- 
posits be  held  by  the  banks  in  reserve,  but  these  reserves, 
according  to  the  law,  can  never  under  any  circumstances  be 
used.  It  is  very  much  as  if  the  Government,  having  estab- 


LEDGER  BALANCES  INFLEXIBLE  675 

lished  naval  and  military  reserve  forces  in  times  of  peace, 
were  to  insist  that  these  forces  should  not  be  used  in  time  of 
war,  in  order  to  maintain  them  intact  as  reserves.  Whenever 
the  cash  held  by  a  bank  has  fallen  to  the  required  minimum, 
the  bank  cannot  legally  continue  to  extend  accommodation. 
It  cannot  issue  more  notes  unless  it  has  additional  government 
bonds  to  deposit  for  their  security,  and  it  cannot  enlarge  its 
ledger  balances  unless  it  has  additional  reserves.  No  matter 
what  may  be  the  stress  of  an  emergency,  or  whether  it  is  due 
to  war,  catastrophe,  or  unreasoning  fear,  there  are  no  legal 
means  for  relaxing  this  requirement.  And  so,  in  moments 
of  great  sensitiveness  and  anxiety,  legal  spokes  are  apt  to  be 
suddenly  thrust  into  the  wheels  of  credit,  and  the  whole 
machinery  of  business  brought  crunching  to  a  standstill.  A 
second  essential  then  of  any  adequate  currency  plan  is  some 
provision  which  will  render  the  reserve  requirements  pliable 
and  the  reserves  of  possible  use. 

NEED  OF  BANKERS'  BANK 

Our  banks  also  have  less  flexibility  in  their  power  to  lend 
ledger  balances  than  the  banks  of  practically  all  other  coun- 
tries for  another  reason,  because  of  the  lack  of  any  permanent 
institution  or  institutions  which  can  perform  for  them  services 
similar  to  those  which  they  perform  for  their  customers.  An 
individual  bank  makes  the  money  of  each  and  all  of  its  custom- 
ers flexible  in  amount,  by  rendering  it  of  mutual  service,  and 
available  to  those  who  most  need  it,  when  they  most  need  it, 
and,  in  order  that  the  money  of  individual  banks  may  be  simi- 
larly flexible  in  amount,  of  mutual  service  to  each  other  and 
available  to  those  institutions  which  most  need  it,  when  they 
most  need  it,  they  require  in  their  turn  some  agency  which  will 
do  for  them  severally  and  jointly  what  they  do  for  the  general 
public.  .  .  . 

It  does  not  matter  what  such  an  agency  may  be  called.  It 
may  be  a  discount  bureau,  or  a  rediscount  bureau,  a  national 
clearing  house,  or  a  national  or  regional  reserve  association. 
Out  of  deference  to  those  great  financial  experts  who  write 
the  banking  clauses  of  political  platforms  and  whose  bans 
and  edicts  are  blessed  with  sacerdotal  infallibility,  when  such 


676  DEFECTS  OF  OUR  BANKING  SYSTEM 

an  institution  is  proposed  for  this  country,  it  must  not  be 
called  a  central  bank.  Such  an  institution  is  perhaps  most 
plainly  designated  if  it  is  called  a  "  bankers'  bank,"  but  by 
whatever  name  it  is  referred  to,  the  need  of  such  an  institu- 
tion is  the  fact  of  primary  importance  in  the  American  bank- 
ing situation. 

Just  as  an  individual  bank  economizes  and  mobilizes  and 
makes  flexible  in  amount  the  funds  of  individual  members  of 
a  community,  so  a  bankers'  bank  mobilizes  and  economizes 
and  makes  flexible  in  amount  the  money  of  the  banks.  It 
collects  money  from  institutions  and  localities  when  and 
where  they  do  not  need  it,  and  lends  it  to  others  when  and 
where  they  do.  In  like  manner  the  active  deposits  of  the 
various  banks,  as  they  are  not  all  wanted  simultaneously, 
furnish  the  bankers'  banks  with  a  large  surplus  reserve  of 
lending  power,  which  in  turn  is  an  invaluable  source  of  flexi- 
bility to  the  individual  banks.  By  its  means  they  can,  if  need 
be,  rediscount  their  commercial  paper,  exchange  their  un- 
matured  assets  for  actual  cash,  and  secure  its  still  better 
known  credit  in  place  of  their  own.  By  its  means  their  re- 
serves can  be  replenished  and  their  lending  power  made  re- 
sponsive to  the  needs  of  their  communities.  A  bankers'  bank 
makes  it  possible  for  the  money  of  the  individual  banks  to  do 
many  times  the  work  it  would  do  if  left  in  the  separate  insti- 
tutions, and  to  do  it  far  more  effectively.  It  is  the  only  ulti- 
mate safeguard,  the  only  scientific  deposit  guarantee,  the  only 
sound  basis  of  flexibility  in  any  banking  system.  As  some 
philosopher  once  said  of  God  —  if  such  an  institution  did  not 
already  exist,  people  would  certainly  have  to  invent  one,  and, 
as  we  have  no  such  institution  permanently  and  legally  estab- 
lished in  America  to-day,  the  prime  essential  of  any  sufficient 
banking  plan  is  the  equipment  of  our  system  in  some  zozv  or 
other  with  the  facilities  of  a  bankers'  bank. 

THE  PARCELLATION  OF  RESERVES 
1  If  the  absolute  certainty  of  ability  to  pay  all  depositors  in 

1  Adapted  from  John  Perrin,  What  is  Wrong  with  Our  Banking  and 
Currency  System?,  The  Journal  of  Political  Economy,  Vol.  19,  No.  10, 
December,  1911,  pp.  856-865. 


PARCELLATION  OF  RESERVES         677 

money  on  demand  be  taken  as  the  smnmum  bonum  of  bank- 
ing, an  idea  which  quite  generally  prevails  among  the  un- 
thinking, it  is  interesting  to  reckon  the  cost.  A  bank  has  no 
fairy  wand  with  a  wave  of  which  it  can  transmute  into  gold 
the  amounts  due  it,  whether  represented  by  borrowers'  notes 
or  balances  due  from  other  banks.  Such  repayments  have 
an  element  of  uncertainty  which  pervades  all  human  affairs. 
All  uncertainty  could  be  eliminated  only  by  having  in  money 
on  hand  an  amount  equal  to  the  total  of  liabilities  to  deposit- 
ors. A  deposit  with  a  bank  would  then  be  simply  a  ware- 
housing transaction. 

If  a  readjustment  to  such  a  condition  were  accomplished, 
and  if  we  consider  only  the  ultimate  result,  and  not  the 
cataclysm  of  the  process,  it  would  clearly  prove  such  an  ex- 
tinguishing restriction  of  commerce  as  would  cost  fabulously 
more  than  the  value  of  the  advantage  gained.  It  would  be 
like  preferring  the  constitution  of  a  jelly-fish  to  that  of  a 
human  being  in  order  to  avoid  the  hazard  of  fracturing  a 
bone. 

Only  by  having  banks  which  employ  in  loans  a  part  of 
depositors'  capital  lodged  with  them,  can  the  best  interests 
of  the  whole  people  be  served,  even  if  this  entails  something 
less  than  an  absolute  certainty  of  power  to  liquidate  deposits 
on  demand.  That  banking  system  must  then  be  best  which 
combines  equally  the  largest  measure  of  each  of  two  elements : 
the  use  in  commerce  of  funds  deposited,  and  the  certainty  of 
paying  depositors  in  money  on  demand. 

Turning  now  to  the  vast  system  of  banks  throughout  the 
country,  if  the  separate  reserves  of  all  the  banks  were 
gathered  into  one  mass,  available  to  meet  the  demands  of 
depositors  for  payment  in  money,  whether  made  in  Maine  or 
Texas,  New  York  or  California,  the  banks  of  the  whole 
system  would  be  able  to  operate  with  the  highest  degree  of 
safety  by  having  a  total  sum  of  money  equal  to  only  a  small 
percentage  of  the  aggregate  amount  owing  to  depositors,  and 
consequently  would  be  able  to  lend  for  use  in  the  commerce 
of  the  country  the  greater  proportion  of  the  funds  deposited. 
The  total  of  deposits  and  withdrawals  made  throughout  the 
country  would  very  nearly  offset  one  another.  Very  little  of 


678  DEFECTS  OF  OUR  BANKING  SYSTEM 

the  reserve  money  would  actually  be  used.  A  special  require- 
ment of  one  section  would  represent  only  a  small  percentage 
of  the  total  massed  reserves.  The  country  has  such  vast  area, 
and  the  requirements  in  different  parts  so  vary  in  season  that 
a  deficiency  of  money  in  some  sections  would  find  a  measur- 
ably offsetting  surplus  in  others. 

While  theoretically  an  institution  so  constituted  would  be 
strongest  and  most  efficient,  none  such  exists,  and  no  one 
would  advocate  such  a  system.  Omniscience  and  omnipo- 
tence would  be  required  for  its  wise  administration. 

But  the  conclusion  seems  clear  that  only  in  proportion  to 
the  massing  of  reserves  can  efficiency  in  lending  for  com- 
merce be  combined  with  strength  to  pay  depositors.  The 
greater  the  proportion  of  the  entire  reserves  gathered  into 
one  mass,  the  greater  the  efficiency  and  strength  rendered 
possible.  This  principle  is  fundamental. 

The  fundamental  defect  of  our  banking  system,  then,  is 
the  parcellation  of  the  entire  reserves  among  the  separate  self- 
independent  banks,  necessitating  either  a  waste  fully  large  pro- 
portion of  reserve  for  assured  ability  to  pay,  with  correspond- 
ingly inefficient  service  to  commerce,  or  efficient  service  with 
the  hazard  of  unexpected  exhaustion  of  reserves  and  conse- 
quent inability  to  make  good  the  contracts  to  pay  depositors  in 
money  on  demand. 

1  If  after  a  prolonged  drought  a  thunderstorm  threatens, 
what  would  be  the  consequence  if  the  wise  mayor  of  a  town 
should  attempt  to  meet  the  danger  of  fire  by  distributing  the 
available  water,  giving  each  house  owner  one  pailful?  When 
the  lightning  strikes,  the  unfortunate  householder  will  in  vain 
fight  the  fire  with  his  one  pailful  of  water,  while  the  other 
citizens  will  all  frantically  hold  on  to  their  own  little  supply, 
their  only  defence  in  the  face  of  danger.  The  fire  will  spread 
and  resistance  will  be  impossible.  If,  however,  instead  of 
uselessly  dividing  the  water,  it  had  remained  concentrated  in 
one  reservoir  with  an  effective  system  of  pipes  to  direct  it 
where  it  was  wanted  for  short,  energetic,  and  efficient  use,  the 
town  would  have  been  safe. 

1  Paul  M.  Warburg,  The  Discount  System  in  Europe,  Publications  of  the 
National  Monetary  Commission,  Senate  Document,  No.  402,  6ist  Congress, 
2nd  Session,  pp.  33,  34. 


OVERLAPPING  RESERVES  679 

We  have  parallel  conditions  in  our  currency  system,  but, 
ridiculous  as  these  may  appear,  our  true  condition  is  even 
more  preposterous.  For  not  only  is  the  water  uselessly  dis- 
tributed into  21,000  pails,  but  we  are  permitted  to  use  the 
water  only  in  small  portions  at  a  time,  in  proportion  as  the 
house  burns  down.  If  the  structure  consists  of  four  floors, 
we  must  keep  one-fourth  of  the  contents  of  our  pail  for  each 
floor.  We  must  not  try  to  extingush  the  fire  by  freely  using 
the  water  in  the  beginning.  That  would  not  be  fair  to  the 
other  floors.  Let  the  fire  spread  and  give  each  part  of  the 
house,  as  it  burns,  its  equal  and  inefficient  proportion  of 
water.  Per  eat  mundus,  fiat  justitia! 

REDEPOSITED  OR  OVERLAPPING  RESERVES 

1  If  we  are  to  understand  the  radical  change  which  will  be 
worked  by  the  Federal  Reserve  Act  in  the  reserve  situation 
in  this  country  it  is  necessary  to  examine  at  some  length  the 
system  heretofore  prevailing.  Under  the  National  Bank  Act 
these  banks  were  divided  into  three  groups  or  classes,  referred 
to  as  the  country  banks,  the  reserve  city  banks  and  the  central 
reserve  city  banks. 

There  are  three  central  reserve  cities:  New  York,  Chi- 
cago, and  St.  Louis.  Every  national  bank  in  these  cities  is 
a  central  reserve  city  bank.  The  reserve  cities  are  forty- 
seven  in  number  and  include  the  larger  cities  of  the  country. 
Every  bank  not  situated  in  any  one  of  the  three  central  reserve 
cities  or  the  forty-seven  reserve  cities  is  a  country  bank. 
This  last  term  includes  all  the  national  banks  of  the  smaller 
cities  in  the  country,  of  the  manufacturing  towns  and  com- 
munities of  New  England  and  the  Middle  States  and  thou- 
sands of  national  institutions  doing  business  in  the  agricul- 
tural sections. 

The  Country  Banks. — The  country  banks,  by  the  terms 
of  the  National  Bank  Act,  are  required  to  keep  a  cash  re- 
serve at  all  times  equal  to  15  per  cent,  of  their  deposits. 
Under  the  old  law  the  country  bank  must  keep  only  40  per 

1  Conway  and  Patterson,  The  Operation  of  the  New  Bank  Act,  pp.  203- 
207.    J.   B.  Lippincott  Company.     Philadelphia.     1914. 


680  DEFECTS  OF  OUR  BANKING  SYSTEM 

cent,  of  this  required  reserve  in  its  own  vaults,  while  it  is 
allowed  to  deposit  60  per  cent,  of  the  required  reserve  on  call 
in  such  national  banks  in  any  of  the  reserve  cities  or  central 
reserve  cities  as  may  be  approved  as  "  reserve  agents  "  for  it 
by  the  Comptroller  of  the  Currency.  .  .  . 

The  Reserve  and  Central  Reserve  Cities. — The  second 
class  of  national  banks,  known  as  reserve  city  banks,  in- 
cludes all  national  banks  located  in  forty-seven  cities  of  the 
country,  which  from  time  to  time  have  been  designated  as 
reserve  cities.  Every  national  bank  in  them  is  required  to 
keep  a  reserve  at  all  times  equal  to  at  least  25  per  cent,  of  its 
deposits.  It  must  be  borne  in  mind  that  the  deposits  of  a 
reserve  city  bank  include  not  only  what  the  banker  refers  to 
as  individual  deposits  —  the  deposits  of  individuals,  firms, 
partnerships,  and  corporations  —  but  also  deposits  which  have 
been  made  with  the  reserve  city  bank  by  country  banks,  for 
which  it  is  the  reserve  agent. 

A  reserve  city  bank  is  permitted  by  the  National  Bank  Act 
to  keep  one-half  of  its  required  reserve  on  deposit,  subject  to 
withdrawal  on  demand,  in  a  national  bank  or  banks  in  a  cen- 
tral reserve  city,  approved  by  the  Comptroller  of  the  Cur- 
rency, as  its  reserve  agent.  .  .  . 

Every  national  bank  within  the  central  reserve  cities  must 
keep  a  reserve  equal  in  amount  to  at  least  25  per  cent,  of  its 
deposits,  including  not  only  individual  deposits  but  deposits 
by  bankers  for  whom  it  acts  as  reserve  agent  or  correspondent. 

The  Reasons  for  the  System. — This  rather  complicated 
system  of  reserves  was  authorized  by  Congress  because  it 
was  necessary  to  allow  the  banks  of  the  country  districts  or 
smaller  cities  to  keep  reserves  in  other  banks  in  the  larger 
centres  of  trade  in  order  to  facilitate  the  commercial  ex- 
changes of  the  country;  and  also  because  it  was  necessary  to 
have  some  means  by  which  banks  of  the  larger  cities  could 
finance  payments  for  their  customers  in  the  great  centres  of 
the  country,  especially  in  New  York,  Chicago,  and  St. 
Louis.  .  .  . 

Its  Weaknesses. — Our  system  of  deposited  reserves  has 
failed  miserably  in  times  of  stress,  although  it  has  worked 
reasonably  well  in  ordinary  times.  It  is  contended  that  it 


OVERLAPPING  RESERVES  68 1 

has,  to  a  large  degree,  built  up  the  great  centres,  and  more 
especially  New  York  City,  at  the  expense  of  country  districts. 
It  has  been  responsible  for  the  seasonal  withdrawal  of  money 
which  was  at  one  time  a  most  serious  embarrassment  to  busi- 
ness, especially  in  New  York,  Chicago,  and  other  large  cities 
in  the  fall  months,  but  which  has  practically  disappeared  in 
New  York  City  since  the  panic  of  1907.  ...  It  was  not  until 
the  system  of  deposited  reserves  brought  about  the  panic  of 
1907  that  the  country  at  large  became  convinced  that  this 
feature  of  the  national  banking  system  was  vicious,  danger- 
ous, and  likely  to  produce  trouble  at  any  time.  With  this 
conviction  began  the  movement  which  finally  ended  in  the 
enactment  of  the  Federal  Reserve  Act. 

Much  of  Our  Reserve  Fictitious. — As  a  matter  of  fact, 
the  actual  available  reserves  of  the  three  classes  of  national 
banks  in  the  country  are  much  less  than  is  indicated  by  the 
percentage  specified  in  the  act  quoted  above.  .  .  .  This  condi- 
tion is  referred  to  frequently  as  the  pyramiding  of  reserves, 
which  means,  in  substance,  that  the  national  banks  of  this 
country,  omitting  from  consideration  the  state  banks  where 
the  same  conditions  exist  in  an  even  more  aggravated  form, 
are  doing  business  largely  upon  a  paper  reserve,  which  experi- 
ence has  shown  is  utterly  useless  in  times  of  panic.  The 
seven  thousand  five  hundred  and  nine  national  banks  held 
cash  and  paper  reserves  on  October  21,  1913,  as  follows: 

Cash  in  Due  from 
vaults.  banks. 

Country   banks    ' $294,000,000  $534,000,000 

Reserve  city  banks   251,000,000          258,000,000 

Central  reserve  city  banks   381,000,000 

$926,000,000        $792,000,000 

As  a  matter  of  fact  the  national  banks  of  the  country  held 
$926,000,000  in  cash  as  against  total  deposits  subject  to  re- 
serve requirements  of  $7,172,000,000,  or  about  12.8  per  cent, 
of  the  liabilities  subject  to  the  requirements. 

Dangers  of  the  System. — So  conclusive  are  the  lessons 
to  be  learned  from  the  experience  of  the  last  half  century 
with  the  system  of  redeposited  reserves,  that  there  is  a  prac- 
tical unanimity  among  bankers  and  financial  experts  that  the 


682  DEFECTS  OF  OUR  BANKING  SYSTEM 

reserves  of  our  banks,  with  the  exception  of  the  money 
actually  held  in  the  vaults,  are,  in  the  words  of  William  Ingle, 
vice-president  of  the  Merchants  and  Mechanics  National  Bank 
of  Baltimore,  "A  great  deal  of  a  delusion  and  a  snare."  In 
every  panic,  the  country  banks  and  the  reserve  city  banks 
have  found  that  it  has  been  impossible  for  them  to  secure 
the  return  of  the  portion  of  these  reserves  which  has  been  re- 
deposited  in  New  York,  Chicago,  and  St.  Louis.  At  a  time 
of  great  stress,  when  the  banks  have  been  subjected  to  a 
drain,  they  have  been  suddenly  bereft  of  the  support  which, 
in  theory,  should  have  been  forthcoming  from  their  reserve 
agents,  and  have  been  forced  to  depend  upon  the  6  per  cent, 
or  12^2  per  cent,  reserve,  which  was  contained  in  their  own 
vaults.  What  is  even  worse,  the  outbreak  of  a  panic  in  New 
York  City,  where  every  panic  of  the  last  half  century  has 
started,  was  the  signal  for  the  suspension  of  cash  payments 
by  every  bank  in  the  country,  within  a  few  hours.  .  .  .  Thus 
a  local  panic,  in  many  cases  occurring  when  business  condi- 
tions were  exceedingly  prosperous  and  healthy,  has  completely 
disorganized  the  exchanges  of  the  country  and  brought  busi- 
ness to  a  standstill. 


THE  PERVERSE  ELASTICITY  OF  NATIONAL  BANK  NOTES 

1  ...  It  is  not  quite  correct  to  call  our  national  bank  notes 
inelastic.  They  are  decidedly  elastic.  The  trouble  is  that 
their  elasticity  is  of  a  wrong  sort;  they  expand  when  there  is 
need  of  contraction,  and  contract  when  the  need  is  for  more 
currency.  By  calling  the  notes  inelastic  we  mean  that  their 
volume  does  not  correspond  automatically  to  the  need  for 
currency.  This  is  true,  and  is  one  of  the  most  serious  de- 
fects of  the  bond-secured  notes.  .  .  . 

The  demand  for  currency  depends  upon  the  volume  of 
business  to  be  transacted,  and  is  continually  in  a  state  of  fluc- 
tuation. Various  causes  have  only  to  be  mentioned  to  explain 
the  unequal  demand  at  different  times.  We  have  thus  the 
payments  of  salaries,  bills,  etc.,  coming  usually  on  the  first 

1  Fred  Rogers  Fairchild,  Bond-Secured  Bank  Notes  and  Elasticity,  The 
Outlook,  Vol.  88,  No.  ii,  March  14,  1908,  pp.  590-93. 


OUR  BANK  NOTES  PERVERSELY  ELASTIC  683 

of  each  month.  Then  there  are  the  quarterly  payments  of 
dividends,  interest,  etc.,  falling  generally  on  the  first  of  Janu- 
ary and  at  intervals  of  three  months  thereafter  during  the 
year.  Above  all,  we  have  in  this  country  a  regularly  re- 
curring seasonal  change  in  the  volume  of  business,  due  to  the 
harvesting  and  moving  of  the  crops  every  fall  and  early 
winter.  Besides  these  normal  fluctuations  in  the  demand  for 
currency  there  are  of  course  such  abnormal  circumstances 
as  business  emergencies,  panics,  depressions,  etc.,  which  at 
irregular  intervals  call  for  expansion  or  contraction  of  the 
currency.  To  meet  all  these  varied  demands  an  elastic  cur- 
rency is  a  necessity. 

The  most  serious  evils  of  inelasticity  in  this  country  are 
seen  in  connection  with  the  annual  handling  of  the  crops.  It 
may  be  safely  said  that  for  this  purpose  the  United  States 
needs  every  fall  at  least  one  hundred  and  fifty  million  dollars 
of  extra  currency.  Since  our  monetary  system  contains  no 
really  elastic  element,  this  extra  business  of  the  fall  has  to 
be  done  with  little  or  no  increase  of  the  country's  currency. 
The  crops  must  be  handled  by  means  of  a  shifting  of  cur- 
rency from  one  part  of  the  country  to  another.  In  the  spring 
and  early  summer  the  agricultural  districts  are  apt  to  have 
more  money  than  they  need.  Accordingly,  the  country  banks 
are  in  the  habit  of  depositing  part  of  their  reserves  in  banks 
situated  in  the  reserve  cities.  A  large  part  of  these  sums 
eventually  finds  its  way  into  the  money  markets  of  New  York 
and  other  Eastern  cities,  where  a  low  rate  of  interest  is  paid 
to  outside  banks  for  such  deposits.  Now  comes  the  harvest 
season,  and  a  demand  goes  up  from  the  country  banks  for 
the  return  of  their  deposits.  Every  fall  the  clearing-house 
banks  of  New  York  City  alone  give  up  about  fifty  millions 
of  "lawful  money"  to  meet  this  demand.1  Of  course  this 
means  a  tight  money  market.  In  the  spring  and  summer  the 
funds  obtained  from  the  country  banks  were  loaned  out  or 
used  as  reserves  for  deposits.  Money  was  in  excess,  interest 
rates  were  low,  and  speculation  was  encouraged.  Now  loans 

1  [As  was  pointed  out  in  an  earlier  chapter,  the  autumnal  demand  for 
currency  in  the  agricultural  sections  of  the  country  has  fallen  off  ap- 
preciably since  1907.] 


684  DEFECTS  OF  OUR  BANKING  SYSTEM 

must  be  called  in  and  deposits  reduced.  This  sudden  con- 
traction is  a  hard  blow  to  all  business  interests.  It  is  especially 
hard  on  the  speculators,  and  their  desperate  demands  cause 
the  enormous  rates  on  call  loans  which  are  witnessed  every 
fall  on  the  New  York  money  market.  .  .  . 

It  has  .  .  .  been  suggested  that  the  inelasticity  of  the  na- 
tional bank  notes  does  not  mean  that  their  volume  never 
changes.  As  a  matter  of  fact,  the  circulation  has  been  marked 
by  enormous  fluctuations,  and  these  fluctuations,  having  no 
relation  to  the  demands  of  business,  have  simply  aggravated 
the  evils  of  inelasticity  which  have  been  described.  Thus,  be- 
tween June  i,  1880,  and  June  i,  1891,  the  total  volume  of 
bank  notes  outstanding  declined  from  $345,000,000  to 
$169,000,000,  a  decrease  of  $176,000,000,  or  51  per  cent. 
This  retirement  of  half  the  circulation  came  during  a  decade 
marked  by  large  growth  in  population  and  wealth,  and  by  re- 
markable industrial  expansion  and  business  activity.  The 
reason  for  this  decline  lies  in  the  fact  that  the  Government 
was  using  part  of  its  large  surplus  revenue  to  pay  off  the 
debt.  In  eleven  years  the  Treasury  paid  $1,105,000,000,  re- 
ducing the  debt  by  more  than  half,  something  without  parallel 
in  the  history  of  public  finance.  The  retirement  of  half  the 
debt  caused  a  scarcity  of  United  States  bonds,  and  their 
prices  went  soaring.  Four  per  cents  of  1907  rose  from 
103-113  in  1880  to  125—130  in  1888.  The  inevitable  result 
was  the  decline  of  circulation.  The  opposite  course 'of  events 
has  been  seen  in  recent  years.  .  .  . 

[The  subjoined  diagram  (suggested  by  a  similar  one  for  1902-1906,  ac- 
companying the  article  a  part  of  which  is  here  reproduced)  illustrates 
the  comparative  seasonal  elasticity  of  the  notes  of  our  national  banks  and 
the  circulation  of  the  chartered  banks  of  Canada  for  the  period  1910-1914. 
The  marked  expansion  of  national  bank  notes  in  1914  was  due  to  the 
crisis  brought  on  by  the  outbreak  of  the  European  war.  The  Aldrich- 
Vreeland  notes  which  were  issued  in  that  emergency  were  retired  in  a 
few  months  and  the  volume  of  national  bank  notes  assumed  normal 
proportions. 

For  the  Canadian  statistics  involved  the  editor  is  indebted  to  Mr.  G.  W. 
Morley,  Secretary  of  the  Canadian  Bankers'  Association.] 


OUR  BANK  NOTES  PERVERSELY  ELASTIC 


685 


NATIONAL  BANK  NOTES  UNSOUND  AND  UNSAFE 

J.  .  .  Any  correct  system  of  credit  currency  must  be  based 
on  a  foundation  of  gold.  Bank  credit  is  issued  in  the  two 
forms  of  deposits  and  notes.  The  former  are  based  on  a 
reserve  of  gold,  the  latter  are  not.  We  have  here  a  funda- 
mental weakness  of  our  bank-note  system.  Under  proper 
banking  methods,  deposits  cannot  expand  without  a  propor- 
tional increase  of  the  gold  reserves  of  the  banks.  This  fur- 
nishes the  natural  and  necessary  check  to  inflation.  Our 
bank  notes,  however,  have  no  such  connecting  link  with  the 
business  and  the  monetary  stock  of  the  world.  The  basis  of 
the  American  bank-note  currency  is  the  government  debt,  a 
very  inferior  kind  of  foundation.  Such  a  system  carries  with 
it  the  possibility  of  paper  money  inflation  of  a  peculiarly  dan- 

ipred   Rogers    Fairchild,   Fundamental  Defects   of   the  Bond-Secured 
Bank  Notes,  Bankers  Magazine,  Vol.  LXXVI,  No.  4,  April,  1908,  pp.  487-90. 


686  DEFECTS  OF  OUR  BANKING  SYSTEM 

gerous  kind,  because  its  real  meaning  is  apt  to  be  concealed. 
For  example,  between  January  i,  1900,  and  January  i, 
1908,  the  volume  of  national  bank  notes  outstanding  increased 
from  $246,000,000  to  $690,000,000,  an  expansion  of  $444,- 
000,000.  In  other  words,  the  circulation  nearly  trebled  in 
eight  years.  The  cause  of  this  great  increase  was  not  the 
need  of  more  currency  but  the  changes  in  the  National  Bank 
Act  made  in  1900,  changes  which  made  the  establishment  of 
national  banks  easier  and  the  issue  of  notes  more  profitable. 
.  .  .  The  future  is  likely  to  witness  further  expansion,  unless 
some  change  is  made  in  our  system.  ...  It  is  undoubtedly 
the  present  intention  to  give  ...  to  future  [bond]  issues 
[the  privilege  of  being  used  as  security  for  notes].  Indeed, 
unless  this  privilege  is  given,  there  will  be  no  market  for  the 
2  per  cent,  bonds.  We  may  expect,  there forfe,  to  see  each 
issue  made  the  basis  of  a  further  increase  in  the  volume  of 
bank  notes. 

All  this  means  inflation,  and  inflation  by  means  of  a  cir- 
culating medium  having  no  connection  with  the  gold  stock 
of  the  world.  To  make  room  for  the  additional  currency, 
gold  must  be  forced  to  leave  the  country,  and  our  whole 
monetary  system,  by  no  means  too  strong  to-day,  will  be  weak- 
ened at  its  foundation.  This  is  the  fundamental  difference 
between  expansion  of  credit  by  means  of  deposits  and  ex- 
pansion by  means  of  national  bank  notes.  The  one  is  based 
on  gold ;  the  other  is  based  on  the  government  debt.  When 
deposits  expand,  the  reserves  of  the  banks  must  increase  pro- 
portionately and,  if  carried  far  enough,  the  result  must  be  to 
bring  in  gold  rather  than  to  force  it  out.  In  like  manner,  de- 
posits cannot  for  any  considerable  time  be  in  excess  of  busi- 
ness needs.  But  bank  notes  may  be  increased  indefinitely,  if 
the  Government  only  borrows  enough,  and  the  result  will  be 
the  expulsion  of  gold  whenever  the  currency  becomes  redund- 
ant. That  this  is  an  actually  present  danger  is  sufficiently 
demonstrated  by  the  recent  action  of  the  Secretary  of  the 
Treasury,  who  has  seen  fit  to  add  to  the  national  debt  at  a 
time  when  the  Treasury  had  a  surplus  of  over  250  millions, 
for  the  sole  purpose  of  increasing  the  circulation  of  the  na- 
tional banks.  Our  currency  system  can  never  be  Sound  until 


BANK  NOTES  UNSOUND  AND  UNSAFE  687 

the  bank  circulation  is  entirely  divorced  from  the  govern- 
ment debt. 

The  danger  of  inflating  our  monetary  system  with  bank 
notes  having  no  gold  reserve  back  of  them  is  all  the  more 
serious  from  the  fact  that  the  notes  of  the  national  banks  are 
used  as  reserves  by  state  banks,  private  banks,  trust  com- 
panies, etc.  They  are  part  of  the  "  cash  reserves  "  on  which 
these  banks  base  their  deposits.  Thus  we  have  a  system  of 
credit  based  on  credit,  and  any  weakness  in  the  national  bank 
note  is  carried  over  and  multiplied  in  the  deposits  of  other 
banks. 

The  complete  reductio  ad  absurdiim  of  this  multiple  credit 
system  came  when  at  a  recent  convention  of  the  American 
Bankers'  Association  it  was  seriously  proposed  that  it  be  made 
lawful  for  national  banks  to  count  their  notes  as  "  lawful 
money  "  in  their  own  reserves.  There  is  good  reason  to  be- 
lieve that  this  is  actually  practised  to  some  extent  by  national 
banks  to-day,  though  the  practice  is,  of  course,  illegal. 

The  safety  of  the  national  bank  notes  is  seldom  questioned. 
Whenever  the  evils  of  our  currency  system  are  pointed  out 
and  plans  for  asset  currency  or  other  reforms  are  proposed, 
the  reformer  is  apt  to  be  met  by  the  reply  that,  at  any  rate, 
our  bank  notes  are  perfectly  safe,  and  we  had  better  put  up 
with  their  other  shortcomings  rather  than  launch  out  on  new 
schemes  which  may  possibly  sacrifice  that  safety  which  we 
now  enjoy.  The  foregoing  discussion  should  already  have 
cast  some  suspicion  on  this  complacent  attitude.  It  will  be 
further  weakened  by  a  closer  analysis  of  the  basis  of  the  na- 
tional bank  circulation. 

National  banks  may  issue  their  notes  up  to  the  amount  of 
their  paid-up  capital,  and  up  to  100  per  cent,  of  the  par  value 
of  United  States  bonds  deposited  with  the  Treasury,  but  never 
in  excess  of  the  market  value  of  the  bonds.  The  notes  are 
engraved  by  the  Government  and  issued  to  the  banks.  When 
signed  by  the  proper  officers  of  the  .bank,  they  become  the 
bank's  promise  to  pay  upon  demand  and  may  be  issued  for 
circulation.  The  United  States  Treasury  is  also  required  by 
law  to  redeem  on  demand  all  notes  of  national  banks  pre- 
sented to  it.  For  this  purpose  each  bank  must  keep  with  the 


688  DEFECTS  OF  OUR  BANKING  SYSTEM 

Treasury  a  reserve  fund  equal  to  5  per  cent,  of  its  circulation. 
The  duty  of  the  Treasury  to  pay  notes  on  demand,  however, 
is  not  limited  to  the  amount  of  this  reserve,  but  applies  to  all 
notes  properly  presented.  In  case  of  the  failure  of  a  national 
bank,  the  Treasury  is  required  by  law  to  immediately  redeem 
all  its  notes.  The  Treasury  is  secured  against  loss  by  the 
bonds  deposited,  by  the  5  per  cent,  cash  reserve,  by  its  prior 
lien  on  the  assets  of  the  banks,  and  by  the  personal  liability 
of  the  stockholders  for  an  amount  equal  to  their  stock  invest- 
ments. 

It  is  thus  seen  that  the  popular  idea  that  the  holder  of  a 
national  bank  note  is  secured  against  loss  by  the  government 
bonds  deposited  in  Washington  is  not  strictly  correct.  What 
protects  the  holder  of  a  note  is  the  absolute  responsibility  of 
the  Treasury  to  redeem  all  notes  on  demand.  The  bonds  are 
to  secure  the  Treasury,  not  the  individual  noteholder,  against 
loss.  The  noteholder  is  secured  so  long  as  the  Treasury  is 
able  to  meet  its  legal  obligations. 

Let  us  examine  the  character  of  our  government  bonds  as 
security  to  enable  the  Treasury  to  meet  its  obligations.  To 
understand  the  situation,  it  should  be  remembered  that  the 
leading  purpose  in  the  establishment  of  the  national  banking 
system  was  not  the  creation  of  a  scientific  currency  system. 
The  National  Bank  Act  was  a  war  measure  enacted  largely 
for  the  purpose  of  improving  the  market  for  government 
bonds  during  the  Civil  War.  It  was  for  this  purpose  that 
the  circulation  of  state  banks  was  forced  out  of  existence  by 
a  10  per  cent,  tax  and  the  right  of  issue  restricted  to  national 
banks  on  condition  of  the  deposit  of  government  bonds  as 
security.  In  the  accomplishment  of  this  purpose  the  act  has 
been  eminently  successful.  United  States  bonds  have  been 
given  a  new  utility  over  and  above  their  utility  as  an  invest-' 
ment.  From  the  very  beginning,  this  has  given  them  an 
added  value  and  enabled  the  Government  to  borrow  at  lower 
rates  of  interest  than  it  would  otherwise  have  had  to  pay. 
The  act  of  March  14,  1900,  made  provision  for  the  ultimate 
refunding  of  all  the  United  States  debt  into  2  per  cent,  bonds, 
and  gave  an  added  inducement  to  the  use  of  these  bonds  as 
note  security  by  lowering  the  annual  tax  on  circulation  from 


BANK  NOTES  UNSOUND  AND  UNSAFE  689 

I  per  cent,  to  one-half  of  i  per  cent.,  provided  the  notes  were 
secured  by  the  new  2  per  cent,  bonds.  All  bonds  issued  since 
1900  have  borne  2  per  cent,  interest.  Yet  the  market  value 
of  these  bonds  has  always  stood  above  par.  .  .  .  Obviously, 
this  value  is  not  based  on  earnings.  British  consols  paying 
2.y2  per  cent,  are  to-day  quoted  in  the  neighborhood  of  85, 
which  makes  them  yield  about  3  per  cent,  on  the  investment. 
The  French  and  German  3  per  cent,  loans  are  both  consider- 
ably below  par.  United  States  bonds  have  been  given  an 
artificial  value  through  their  use  as  security  for  bank  circula- 
tion. The  national  banks  to-day  hold  for  this  purpose  about 
two-thirds  of  the  total  funded  debt  of  the  United  States. 
Remove  this  privilege  from  the  national  debt,  and  we  should 
see  the  2  per  cent,  bonds  (which  compose  two-thirds  of  the 
interest-bearing  debt  of  the  United  States)  fall  to  perhaps 
seventy  cents  on  the  dollar,  very  likely  even  lower. 

Here  we  have  a  remarkable  situation.  Our  national  bank 
notes  are  safe  because  they  are  secured  by  government  bonds, 
and  our  government  bonds  are  valuable  because  they  are  se- 
curity for  national  bank  notes.  This  looks  very  much  like 
lifting  oneself  by  one's  bootstraps. 

If  we  are  to  cling  to  the  bond-secured  note  system,  this 
matter  of  the  artificial  value  of  government  bonds  will  be- 
come an  important  practical  problem  whenever  it  becomes 
necessary  for  the  United  States  to  make  any  addition  to  its 
debt.  Either  the  rate  pf  interest  will  have  to  be  raised  to 
3  per  cent,  or  higher,  or,  if  that  alternative  is  rejected,  means 
will  have  to  be  found  to  induce  the  banks  to  use  the  greater 
part  of  the  new  loans  as  security  for  additional  note  issues.1 
In  practical  effect,  this  is  only  a  thinly  disguised  resort  to  the 
time-honored  but  now  thoroughly  discredited  practice  of  com- 
pelling the  people  to  use  the  government  debt  as  a  circulating 
medium. 

The  bearing  of  this  matter  on  the  safety  of  the  national 
bank  note  is  simple.  The  burden  of  the  ultimate  redemption 
of  the  bank  notes  has  been  placed  on  the  shoulders  of  the 
Treasury,  to  add  to  its  other  burdens  of  maintaining  the  value 

JWe  are  not  considering  the  third  alternative  of  issuing  bonds  at  a 
heavy  discount. 


690  DEFECTS  OF  OUR  BANKING  SYSTEM 

of  the  greenbacks  and  of  the  silver  dollars.  If  loss  of  confi- 
dence in  the  bank  notes  should  ever  lead  people  to  demand 
their  wholesale  redemption,  the  Treasury  would  have  to  meet 
the  demand  in  gold.  But  the  moment  it  tried  to  sell  the 
bonds,  it  would  find  there  was  no  market  for  them  except  at 
a  discount  of  perhaps  30  or  40  per  cent.  It  is  true  that  the 
Treasury  would  still  be  able  to  recoup  itself  for  this  loss  in 
the  value  of  the  bonds  by  exercising  its  prior  lien  on  the 
assets  of  the  banks.  But  this  leads  us  to  the  important  con- 
clusion that  the  final  security  for  our  bond-secured  notes  rests 
on  the  assets  of  the  banks  after  all".  A  more  striking  argu- 
ment for  asset  currency  could  hardly  be  discovered. 

It  must  be  remembered,  however,  that  the  foreclosure  by 
the  Government  of  its  claim  on  the  assets  of  the  national 
banks  would  cut  into  the  wealth  on  which  deposits  are  based 
and  so  have  a  most  disastrous  effect  on  the  deposit  system. 
The  pressure  upon  the  Government  to  refrain  from  such  a 
crushing  blow  to  credit  would  be  overwhelming.  It  is  almost 
inconceivable  that  in  time  of  panic  or  a  national  crisis  the 
Government  would  resort  to  such  a  procedure.  Almost  any 
alternative  would  be  preferred.  It  would  not  be  too  difficult 
a  matter  for  the  Government  to  persuade  itself  that  the  wiser 
and  safer  course  would  be  to  suspend  specie  payments,  per- 
haps even  declaring  the  bank  notes  a  legal  tender.  A  more 
plausible  case  could  be  made  out  in  favor  of  such  action  than 
was  found  sufficient  to  justify  the  issue  of  the  greenbacks  of 
the  Civil  War.  Yet  such  action  would  mean  the  breakdown 
of  our  financial  system. 

This  is,  of  course,  looking  into  the  future  and  anticipating 
a  state  of  disaster  which  may  never  come.  But  a  system 
which  bids  fair  to  break  down  in  time  of  disaster  should  be 
remodelled  before  disaster  comes.  And  we  should  not  rest 
too  confidently  in  the  notion  that  disaster  can  never  reach  us. 
It  is  only  thirteen  years  ago  [1895]  that  the  burden  of  sup- 
porting its  paper  and  silver  currency  brought  the  United 
States  within  twenty-four  hours  of  suspension.  .  ,  . 


SPECULATION  IN  NOTE  ISSUE  691 


1  When  a  banker  takes  out  currency  he  engages  in  two  dis- 
tinct transactions  and  enters  upon  two  different  hazards.  In 
one  transaction  he  assumes  the  risk  and  holds  the  expectation 
of  greater  profit  for  taking  out  circulation.  Since  buying 
bonds  and  taking  out  circulation  most  of  the  time  shows  some 
theoretical  profit  over  loaning  direct,  presumably  if  there  were 
no  other  consideration,  most  of  the  time  our  bankers  would 
keep  outstanding  all  the  notes  they  could.  In  the  other  trans- 
action, however,  the  banker  engages  in  a  speculation  in  gov- 
ernment securities.  As  a  matter  of  fact,  if  the  price  of 
government  bonds  advances,  the  profit  from  taking  out  cir- 
culation declines ;  but  our  banker  is  pretty  likely  to  view  with 
equanimity  the  declining  circulation  profit  when  he  considers 
the  profit  he  is  making  in  his  speculation  in  bonds.  On  the 
other  hand,  as  the  price  of  government  bonds  declines,  circu- 
lation grows  more  profitable.  The  banker  is  likely  to  view 
this  with  sour  satisfaction  when  he  looks  on  his  loss  in  his 
bond  speculation.  Profit  or  loss  in  the  bond  speculation  is 
likely  to  outbalance  loss  or  profit  in  the  circulation  transac- 
tion.2 

Let  us  examine  the  situation  more  closely.  Just  what  is 
the  profit  or  loss  from  taking  out  circulation?  In  the  first 
place  the  bank  gets  the  regular  current  money  rates  on  the 
loans  it  makes  through  issuing  notes.  Also  it  gets  the  in- 
terest on  the  government  bonds  it  buys.  This,  of  course, 
means  the  real  interest,  or  income  on  the  investment,  called 
basis,  taking  into  consideration  coupon  interest,  price  paid, 
and  date  of  maturity.  Excepting  for  the  tax  of  y2  per  cent, 
on  the  circulation  taken  out  (i  per  cent,  if  taken  out  on  the 
3's  or  4's)  and  for  the  expenses  attendant  on  taking  out  cir- 
culation, which  the  government  actuaries  compute  to  average 
$63  on  the  $100,000,  this  interest  on  the  government  bonds 
looks  like  clear  "  velvet."  It  would  be,  too,  if  the  banker 

1  Adapted  from  W.  H.  Lyon,  A  Gamble  in  Governments,  Moody's  Maga- 
zine. Vol.  XI,  No.  i,  January,  1911,  pp.  181-186. 

2  [In  this  extract  the  explanation  of  the  so-called  perverse  elasticity  of 
our  national  bank  notes  is  given  incidentally  but  very  clearly.] 


692  DEFECTS  OF  OUR  BANKING  SYSTEM 

did  not  have  to  pay  more  for  the  bonds  than  the  amount  of 
circulation  he  can  take  out  against  them.  To  figure  his  net 
profit  he  must  deduct  from  the  gain  items  just  stated  what  he 
would  have  made  if  he  had  loaned  his  funds  direct  instead  of 
investing  in  bonds. 

Expressed  as  an  algebraic  equation  the  situation  becomes 
much  clearer.     Let 
x  =  current  money  rate ; 

y  =  basis  rate  at  which  government  bonds  are  bought ; 
z  =  price  of  government  bonds ; 
b  =  circulation  received  ($100,000  used  as  basis  of  calcula- 

•    tion)  ; 
c  =  taxes,  redemption,  and  other  circulation  expenses. 

(As  already  stated,  government  actuaries  have  calculated 
that  circulation  expenses  average  to  cost  the  banks  $63  on  the 
$100,000  of  circulation  taken  out.  Taxes  depend  on  whether 
the  2's,  in  which  case  the  tax  is  y2  per  cent.,  or  the  3's  or  4's, 
in  which  case  the  tax  is  I  per  cent.,  are  bought.  Taxes,  then, 
amount  to  either  b(.oi)  or  b(.oo5).  We  can  take  b  as  a 
constant  in  our  calculations  and  base  all  our  computations  on 
taking  out  $100,000  of  circulation.) 

The  equation  of  profit  or  loss  on  taking  out  circulation 
then  reads : 

yz  -{-  bx  —  xz  —  c  =  profit  or  loss. 

But  circulation  taken  out  (b)  can  never  be  greater  than  the 
amount  of  money  paid  for  the  bonds  (z). 

If  government  bonds  should  be  at  par  or  at  a  discount,  the 
nominal  profit  would  always  be  just  the  basis  interest  on  the 
bonds,  less  the  tax  and  the  cost  of  taking  out  circulation,  or 
a  constant  advantage  in  the  case  of  the  2's  of  1.437  Per  cent- 
For  the  purpose  of  this  discussion  we  will  consider  only  the 
2's  of  1930. 

In  the  regular  case,  then,  the  money  paid  for  the  bonds  (z) 
is  greater  than  the  amount  of  circulation  received  (b).  With 
that  statement  in  mind  we  can  draw  certain  very  definite  con- 
clusions about  our  circulation  direct  from  the  equation  we 
have  formed ;  z  is  greater  than  b. 

Repeating  the  equation  in  order  to  have  it  directly  before  us : 
yz  -j-  bx  —  xz  —  c  =  profit  or  loss. 


SPECULATION  IN  NOTE  ISSUE  693 

Then  as  the  current  interest  rate  (x)  increases,  if  all  the 
other  quantities  remain  constant,  the  negative  influence  in 
the  equation  grows  greater,  or  profit  from  circulation  de- 
creases. We  can,  then,  make  definitely : 

STATEMENT   I 

//  all  other  circumstances  remain  the  same,  circulation 
grows  less  profitable  as  the  current  money  rate  advances. 

As  business  increases  and  the  demand  for  both  credit  and 
money  increases,  as  reflected  in  the  rising  interest  rates,  taking 
out  circulation  ccctcris  paribus,  with  the  inexorability  of  a 
mathematical  law,  becomes  less  profitable. 

Further,  there  is  an  intimate  relationship  between  y  and  z. 
If  the  price  of  bonds  (z)  declines,  the  basis  rate  (y)  must  ad- 
vance. As  a  matter  of  fact  as  z  declines  yz  grows  greater. 
If,  then,  x  remains  constant  and  z  declines  the  influence  of  the 
negative  quantities  of  the  equation  is  growing  less.  Then 
follows : 

STATEMENT   II 

As  the  price  of  bonds  declines,  if  the  current  interest  rate 
remains  constant,  the  profit  from  taking  out  circulation  in- 
creases. 

That  gives  the  absolute  mathematical  basis  for  such  general 
statements  as  that  "  the  price  of  bonds  is  too  high  to  make 
circulation  profitable." 

These  two  facts  set  out  in  Statement  I  and  Statement  II 
place  the  banker  who  has  taken  out  circulation  between  the 
devil  and  the  deep,  blue  sea.  If  the  price  of  bonds  remains 
the  same  and  the  current  interest  rate  rises,  his  circulation 
grows  steadily  less  profitable.  A  decline  in  the  price  of  bonds 
affords  the  only  offset  to  an  increasing  interest  rate.  But  if 
the  price  of  bonds  declines  enough  to  offset  the  advance  in  the 
current  interest  rate,  the  banks  must  mark  off  enough  profits 
to  cover  the  loss  on  the  capital  value  of  the  bonds. 

Speculating  in  securities  properly  forms  no  part  of  a  bank's 
business.  It  is  an  anomalous  situation  that  in  order  to  fulfil  a 
proper  function  of  note  issue  a  bank  should  have  to  undertake 
such  an  improper  speculation. 


694  DEFECTS  OF  OUR  BANKING  SYSTEM 


THE  LACK  OF  ADJUSTMENT  BETWEEN  BANK  NOTES 
AND  DEPOSITS 

1  Under  our  present  currency  system  the  volume  of  money 
in  circulation  is  perfectly  flexible.  It  constantly  expands  and 
contracts  in  automatic  adjustment  to  the  requirements  of  trade 
and  the  convenience  of  the  people.  An  increase  in  the  volume 
of  cash  transactions  brings  promptly  an  increase  in  the  volume 
of  currency  in  circulation  through  the  current  withdrawals  of 
money  exceeding  the  current  deposits  of  money.  A  lessening 
in  the  volume  of  cash  transactions  promptly  drives  unneeded 
currency  out  of  circulation  through  the  deposits  of  money  ex- 
ceeding the  withdrawals.  No  other  system  could  provide  a 
currency  which  would  adjust  its  volume  in  circulation  more 
exactly  to  the  needs  of  trade  and  the  preferences  of  the  people. 
There  is  a  ceaseless  flow  of  the  money  in  circulation  into  bank 
reserves,  and  of  money  in  bank  reserves  into  circulation  — 
ceaseless  except  in  an  occasional  crisis  when  the  natural  flow 
of  money  from  bank  reserves  into  circulation  is  arbitrarily 
stopped  by  banks  refusing,  for  self -protection,  to  continue 
paying  out  to  the  point  of  exhausting  reserves. 

While  the  volume  of  money  in  circulation  is  thus  perfectly 
and  automatically  adjusted  to  trade  requirements,  it  is  to  be 
noted  that  this  flexibility  arises  from  the  flow  back  and  forth, 
between  the  mass  of  money  in  circulation  and  the  mass  in  bank 
reserves.  In  this  lies  the  main  economic  defect  of  our  present 
currency  system.  An  expansion  in  the  volume  of  money  in 
circulation  entails  a  corresponding  contraction  in  the  volume 
of  bank  reserves,  and  necessarily  a  corresponding  contraction 
in  loans.  A  period  of  expanding  business  would  naturally  be 
attended  by  both  an  increased  volume  of  loans  and  an  in- 
creased volume  of  cash  transactions,  such  as  increased  pay- 
rolls, increased  retail  sales.  Increased  cash  transactions  cause 
a  larger  volume  of  money  to  flow  into  circulation.  But  this 
flow  is  out  of  bank  reserves,  thus  contracting  them  and  neces- 
sitating a  contraction  of  loans  depending  upon  them,  at  the 

1  Adapted  from  John  Perrin,  What  is  Wrong  wth  Our  Banking  and 
Currency  System?,  The  Journal  of  Political  Economy,  Vol.  19,  No.  10 
December,  1911,  pp.  856-865. 


COMMERCIAL  PAPER  SITUATION  695 

very  time  when  loans  would  naturally  expand.  Obviously,  if 
business  becomes  very  active,  the  effect  upon  bank  reserves  is 
so  adverse,  and  the  contraction  of  loans  depending  upon  re- 
serves so  important,  that  embarrassment  is  widespread  and 
panic  ensues. 

The  main  defect,  then,  of  our  present  currency  system  is 
that  the  volume  of  currency  in  circulation  has  its  adjustment 
in  the  flow  from  bank  reserves  into  money  in  circulation  and 
from  money  in  circulation  into  bank  reserves,  causing  a  con- 
traction of  bank  reserves  and  the  loans  depending  on  them  as 
business  expands. 

A  remedy  would  be  the  use  of  bank  notes  through  which 
the  volume  of  currency  in  circulation  would  have  its  adjust- 
ment in  the  flow  from  bank  deposits  into  bank  notes  in  circula- 
tion, and  from  bank  notes  in  circulation  into  bank  deposits, 
thus  protecting  from  disturbance  both  bank  reserves  and  the 
loans  based  on  them. 

THE  COMMERCIAL  PAPER  SITUATION  IN  THE  UNITED 

STATES 

1.  .  .  At  the  present  time  the  commercial  paper  situation  in 
the  United  States  is  peculiar.  "  Commercial  paper  "  in  the 
old  and  strict  sense  is  little  used  in  this  country.  "  Trade 
paper,"  as  it  is  now  called,  arises  in  less  than  3  per  cent,  of 
the  credit  transactions  in  the  United  States.2  In  some  lines 
of  trade,  especially  where  a  local  wholesaler  does  a  large  busi- 
ness with  small  tradesmen,  the  wholesaler  will  extend  credit 
by  taking  the  retailers'  notes ;  but  in  obtaining  credit  for  him- 
self the  wholesaler  will  not  surrender  control  of  the  bundle  of 
retailers'  notes,  preferring  instead  to  give  simply  his  own  note 
on  a  general  understanding  with  his  banker  that  the  personal 
note  rests  on,  and  is  fully  covered  by,  the  retailers'  notes.3 
The  wholesaler  hesitates  to  surrender  to  the  banker  the  notes 
that  he  receives  because  he  fears  that  his  competitors  might 
get  some  inkling  of  his  trade  connections,  etc.  In  general, 

1  Eugene   E.   Agger.   The   Commercial  Paper  Debate.  The  Journal  of 
Political  Economy,  Vol.  22,  No.  7,  July,  1914,  pp.  663-667. 

2  Annalist,  March  9,  1914,  P-  293. 

3  Annalist,  March  9,  1914,  P-  294. 


696  DEFECTS  OF  OUR  BANKING  SYSTEM 

"  trade  paper  "  is  used  to  settle  accounts  only  when  the  credit 
terms  are  still  long,  that  is,  four  months  or  more.1 

What  generally  passes  as  "  commercial  paper  "  in  the  United 
States  is  single-name  paper.  As  in  the  case  of  the  wholesaler 
referred  to  above,  the  borrower  of  bank  credit  in  these  days 
offers  for  discount  simply  his  own  promissory  note.  Some 
of  this  paper,  particularly  corporation  notes,  carries  indorse- 
ments, but  these  are  largely  "  accommodation  "  indorsements, 
which  may  buttress  the  security  of  the  paper  but  which  indicate 
nothing  as  to  its  purpose. 

The  wide  use  of  single-name  paper  in  this  country  is  largely 
explained  by  the  fact  that  the  prevailing  terms  of  payment  in 
business  transactions  are  net  in  30  or  60  days,  with  a  discount 
for  payment  in  cash  within  variously  from  10  days  to  one 
month.  The  cash  discount  allowed  is  usually  so  large  that  a 
purchaser  can  ill  afford  not  to  take  advantage  of  it.  Two  per 
cent,  discount  for  cash  within  10  days,  for  example,  with  "  60 
days  net "  is  equivalent  to  a  return  of  12  per  cent,  per  annum 
on  one's  capital.  In  actual  practice  the  allowance  is  often 
even  more  liberal.  Hence  where  competition  is  at  all  keen 
the  business  man  is  practically  forced  to  adopt  the  system  of 
cash  payments,  depending  upon  his  bank  to  advance  to  him, 
on  his  own  notes,  the  necessary  funds.  Moreover,  so  broadly 
has  the  custom  of  taking  cash  discounts  spread  that  a  failure 
to  take  advantage  of  them  is  generally  regarded  as  an  indica- 
tion of  weakness,  and  tends  to  undermine  general  confidence 
in  the  business  man's  credit  standing.  Hence  the  necessity 
for  maintaining  his  credit  rating,  as  well  as  competition,  vir- 
tually forces  the  business  man  into  making  anticipatory  cash 
payments  and  thus,  more  or  less  as  a  consequence,  into  the 
general  practice  of  discounting  his  personal  paper.2 

Furthermore,  as  business  operations  have  grown  to  a  larger 
and  larger  scale,  especially  in  the  case  of  large  corporate  enter- 
prises, the  credit  needs  of  business  have  in  many  cases  ex- 
panded beyond  the  capacity  of  the  local  banks  to  supply  them. 
The  necessity  arose,  therefore,  to  go  elsewhere  for  accom- 
modation. This  was  met  in  some  cases  by  the  opening  of 

1  J.  J.  Klein,  Annalist,  March  23,  1914,  p.  361. 

2  Ibid . 


COMMERCIAL  PAPER  SITUATION  697 

bank  accounts. in  other  centers,  but  obvious  difficulties  and  re- 
strictions attend  this  method  of  procedure.  More  elastic 
possibilities  and  fewer  difficulties  grew  out  of  the  employment 
of  middlemen  to  market  the  paper  over  the  country  as  a  whole 
on  the  best  available  terms.  Hence  the  note-broker  is  to-day 
an  important  factor  in  the  discount  market.  As  a  result  of 
the  note-broker's  activities  there  has  come  to  be  established  an 
extensive  open  market  for  commercial  (single-name)  paper  in 
this  country,  and  the  rates  at  which  such  paper  is  discounted 
are  regularly  reported  in  the  daily  newspapers. 

This  development  of  a  commercial-paper  market  reflects, 
of  course,  a  considerable  development  of  the  demand  of  the 
banks  for  this  form  of  investment.1  "  Country  banks " 
especially  have  in  the  last  few  years  heavily  increased  their 
purchases  in  the  open  market,  because  the  necessity  of  writing 
off  heavy  losses  due  to  the  shrinkage  of  bond  values  has  tended 
to  make  them  more  timid  about  investing  in  securities,  and 
because  they  have  also  learned  by  experience  that  paper  pur- 
chased through  a  broker  does  not  have  to  be  renewed,  as  does 
most  of  the  purely  local  paper.2 

This  development  has,  of  course,  tended  to  put  an  increas- 
ingly heavy  responsibility  on  the  note-broker  and  has  brought 
about,  at  least  to  some  extent,  a  readjustment  of  his  business 
methods.  At  first  note-brokers  simply  solicited  paper  from 
merchants  and  charged  a  brokerage  fee.  Latterly,  the  custom 
has  grown  up  for  the  broker  to  buy  up  the  paper  outright.3 
This  forces  the  broker  "  to  stand  between  the  maker  and  the 
bank,"  and  to  the  extent  that  any  given  piece  of  paper  may  be 
left  on  his  hands,  even  though  he  does  not  indorse  the  paper 
that  he  sells,  it  compels  him  to  be  very  circumspect  about  the 
paper  that  he  purchases.  Moreover,  some  banks  now  pur- 
chase paper  with  an  option  of  return  within  a  specified  period, 

1  During  1912  over  $1,700.000,000  in  notes  were  sold  by  reputable  brokers, 
and  they  represented  in  these  transactions  from  2,500  to  3,000  concerns.     In 
one  large  eastern  state  over  two-thirds  of  the  state  banks  and  trust  com- 
panies regularly  invest  a  portion  of  their  funds  in  this  class  of  paper  (J. 
A.  Broderick,  Finance,  October  4,  1913,  p.  328).     On  August  9,  1913,  ac- 
cording to  the  report  of  the  Comptroller  of  the  Currency,  the  national 
banks   held  over   six   billions   of   dollars  of   commercial  paper,  most  of 
which  was  single-name. 

2  Financier.  June  22.  1912. 

8  J.  G.  Cannon,  Financial  Age,  October  19,  1908. 


698  DEFECTS  OF  OUR  BANKING  SYSTEM 

making  it  a  point  carefully  to  inquire  about  the  maker  of  the 
paper  before  the  option  expires.  In  the  last  few  years  banks 
as  well  as  brokers  have  established  carefully  organized  credit 
departments,  the  purpose  of  which  is,  through  careful  inquiry 
into  the  character  and  standing  of  sellers  of  paper,  to  enable 
both  brokers  and  bankers  to  select  paper  with  sounder  dis- 
crimination. 

This  characteristically  American  discount  system  differs 
greatly  from  that  which  prevails  in  Europe.  Abroad,  single- 
name  paper  is  very  little  used.1  The  European  banker  de- 
mands more  than  one  signature,  not  only  as  a  guaranty  of 
security,  but  also  as  an  assurance  of  the  validity  of  the  transac- 
tion out  of  which  the  paper  offered  for  discount  grew.  When 
the  prospective  borrower,  for  some  sufficient  reason,  does  not 
wish  to  divulge  the  names  of  his  clients,  as  would  be  necessary 
if  he  drew  bills  on  them,  he  may  arrange  with  his  bank  for  an 
overdraft  (known  as  a  cash  advance),2  or  by  paying  a  small 
commission  he  may  get  the  bank  to  "  accept  "  a  bill  drawn  di- 
rectly on  it.  With  a  bank's  acceptance  a  bill,  even  though 
drawn  by  the  humblest  shopkeeper,  becomes  a  prime  invest- 
ment and  may  be  sold  openly  on  the  market  at  the  lowest  terms 
that  prevail.3  On  the  Continent  bank  acceptances  thus  open 
the  market  widely  to  all  who  can  arrange  for  them,  while  the 
open  market  for  single-name  paper  in  this  country  is  restricted 
to  large  firms  of  established  reputations. 

In  view  of  the  prevailing  practice  in  Europe  it  is  interesting 
to  inquire  why  in  America  there  should  have  been  this  peculiar 
development  in  the  discount  field.  It  has  been  pointed  out 
that  before  the  Civil  War  trade  paper,  as  it  is  now  called,  was 
pretty  generally  used,  but  the  exigencies  growing  out  of  the 
war  completely  changed  the  situation.  The  excessive  issue 
uf  the  greenbacks  and  the  uncertain  value  of  credit  instru- 
ments covering  any  appreciable  period  of  time  led  sellers  to 
endeavor  to  bring  business  to  a  cash  basis.  Credits  were 
shortened  to  30  or  even  to  10  days,  and  strong  emphasis  was 

1  P.  M.  Warburg.  The  Discount  System  in  Europe,  in  Report  of  the 
National  Monetary  Commission. 

2  Ibid.;  see  also  William  Jacobs,  Bank  Acceptances,  in  Report  of  the 
National  Monetary  Commission. 

3  Warburg,  he,  cit. 


NO  SYSTEM  OF  BANK  ACCEPTANCES  699 

placed  on  immediate  payment.  With  cash  discounts  allur- 
ingly liberal,  merchants  could  ill  afford  to  forego  them,  and 
cash  payments  tended  to  become  more  and  more  common. 
Big  houses  offered  single-name  paper  to  raise  the  needed 
funds,  and  little  by  little  the  older  system  of  settling  by  the 
promissory  note  of  the  debtor  was  supplanted  by  the  system 
of  selling  on  open  account,  with  the  choice  given  to  the  debtor 
of  a  liberal  discount  for  cash  or  the  payment  of  the  due 
amount  "  net "  at  the  expiration  of  a  relatively  short  credit 
period. 

The  transition  was  hastened  by  the  development  of  the  prac- 
tice of  selling  goods  by  sample  instead  of  by  personal  selec- 
tion from  an  accumulated  stock.  Under  the  old  practice  the 
buyer  bought  under  the  rule  of  caveat  emptor,  but  when  pur- 
chasing by  sample  he  had  a  right  to  demand  that  the  delivered 
goods  attain  the  standard  of  the  sample,  and  there  grew  up  in 
consequence  the  doctrine  of  "  implied  warranties."  These 
warranties  have  in  some  lines  been  pushed  very  far,1  but  in 
any  case  the  buyer  would  hesitate  to  pay  for  goods  until  he 
had  had  a  chance  to  inspect  them,  and  hence  he  would  as  a  rule 
demand  that  they  be  consigned  to  him  on  open  account.  The 
seller,  however,  cannot  afford  to  wait  for  payment  until  his 
accounts  become  due.  Too  much  of  his  capital  would  be  tied 
up.  He  is  forced,  therefore,  to  go  to  his  banker  and,  on  the 
basis  of  his  accounts  receivable,  to  offer  his  own  note  and  thus 
to  obtain  release  of  the  capital  otherwise  temporarily  beyond 
reach.  .  .  .  Single-name  paper  virtually  monopolizes  the 
field.  .  .  . 

No  SYSTEM  OF  BANK  ACCEPTANCES  AND  THE  ABSENCE  OF 
AN  OPEN  DISCOUNT  MARKET 

2  The  weakness  of  our  banking  system  as  compared  with  the 
systems  of  Europe  may  very  certainly  be  attributed  in  part  to 
the  omission  of  the  bank  act  to  permit  bank  acceptances.  It 
is  a  weakness,  furthermore,  which  involves  the  country  in 

1  E.  D.  Page,  Annalist,  March  16,  1914,  P-  324- 

2  Lawrence  Merton  Jacobs,  Bank  Acceptances,  Publications  of  the  Na- 
tional  Monetary  Commission,   Senate  Document   No.  569,  6ist  Congress, 
2d  Session,  pp.  9-19. 


/OO  DEFECTS  OF  OUR  BANKING  SYSTEM 

serious  economic  loss.  Without  a  national  discount  market, 
the  great  majority  of  our  merchants  and  manufacturers  are 
compelled  to  confine  their  borrowings  to  American  capital, 
either  through  the  discounting  of  their  paper  with  their  local 
banks  or  through  its  sale  to  note  brokers.  All  but  the  strong- 
est and  largest  are  practically  excluded  from  the  benefits  of 
foreign  competition  for  their  paper.  Aside  from  the  great 
concerns  with  international  ramifications,  which  are  able  to 
arrange  their  own  credits  abroad,  our  merchants  and  manu- 
facturers are  not  benefited  by  low  foreign  discount  rates,  ex- 
cept in  so  far  as  note  brokers,  who  make  it  a  practice  to 
borrow  in  Europe  with  commercial  paper  as  collateral,  are 
better  able  to  finance  their  purchases.  What  is  more,  they  re- 
ceive relatively  little  advantage  from  an  accumulation  of  funds 
in  New  York  banks.  Low  call  loan  rates  have  an  indirect 
rather  than  a  direct  effect  on  the  rate  which  the  mercantile 
community  has  to  pay  for  money.  Low  call  rates,  in  other 
words,  are  an  indication  more  especially  of  stagnation  in  the 
stock  market  than  of  a  lack  of  demand  for  accommodation 
from  merchants  and  manufacturers.  Such  rates  do  not  act 
as  a  stimulus  to  trade  in  general  any  more  than  high  call  rates 
act  as  an  immediate  check  to  overexpansion. 

It  is  not  only  in  our  domestic  trade  that  the  country  suffers 
through  the  want  of  a  discount  market.  Without  bank  ac- 
ceptances we  are  at  a  distinct  disadvantage  in  connection  with 
our  foreign  trade.  Our  importers,  unable  to  open  credits 
with  their  banks,  as  is  done  abroad,  are  not  in  a  position  to 
finance  their  purchases  upon  as  favorable  a  basis  as  the 
importers  in  other  countries,  as  English  cotton  spinners,  for 
example.  The  English  spinner  about  to  purchase  cotton  in 
America  arranges  for  his  bank  to  accept  sixty  or  ninety  days' 
sight  bills  drawn  on  it  by  the  American  shipper.  The  latter 
draws  his  bills  on  the  English  bank  and  attaches  the  docu- 
ments covering  the  shipment,  such  as  the  bills  of  lading,  insur- 
ance certificates,  invoices,  etc.  He  then  sells  them  to  a  New 
York  bank,  thereby  receiving  immediate  payment  for  his  cot- 
ton. The  New  York  bank  forwards  the  bills  to  its  London 
correspondent,  which  presents  them  for  acceptance  to  the 
bank  upon  which  they  are  drawn.  Upon  the  acceptance  of  the 


NO  SYSTEM  OF  BANK  ACCEPTANCES  701 

bills  the  documents  are  delivered  to  the  accepting  bank,  which 
then  turns  them  over  to  the  spinner  upon  whatever  arrange- 
ment has  previously  been  made.  The  accepted  bills  are  dis- 
counted by  the  New  York  bank  in  London  and  the  proceeds 
placed  to  its  credit  there.  The  New  York  bank  can  afford  to 
pay  a  high  rate  for  such  bills,  as  they  are  drawn  on  prime 
bankers,  rendering  certain  their  ultimate  payment.  The  pur- 
chase of  the  bills  does  not,  moreover,  necessitate  any  outlay  of 
money,  as  against  the  credit  to  be  received  through  the  dis- 
count of  the  bills  the  New  York  bank  can  immediately  sell  its 
checks  on  London. 

Without  such  banking  facilities  —  that  is,  the  ability  to  ar- 
range with  his  bank  to  accept  time  bills  drawn  on  it  by  a 
foreign  shipper,  the  American  importer  is  compelled  to  finance 
his  purchases  in  either  one  of  two  ways.  He  may  pay  for  the 
goods  at  once  by  remitting  funds  direct  to  the  shipper.  This, 
however,  ordinarily  necessitates  the  negotiation  by  the  im- 
porter of  a  loan  on  his  promissory  note.  If  he  is  not  in  a  posi- 
tion to  secure  such  an  advance  he  must  shift  the  burden  of 
providing  funds  to  finance  the  shipment,  from  the  time  it  is 
forwarded  until  it  is  to  be  paid  for,  upon  the  foreign  shipper, 
who  is  then  in  a  position  to  exact  terms  more  favorable  to 
himself  through  an  adjustment  of  prices.  The  practice  in 
connection  with  this  method  of  making  payment  for  foreign 
purchases  is  for  the  shipper  to  draw  his  draft  on  the  American 
importer  and  turn  it  over  to  his  banker  to  forward  for  collec- 
tion. Such  drafts,  drawn  as  they  are  on  individual  importers 
and  not  on  banks  whose  standing  is  well  known  abroad,  must 
be  sent  for  collection  since  there  is  no  general  market  for  them. 
Practically  the  only  way  in  which  a  foreign  shipper  can  realize 
immediately  on  bills  of  this  character  is  to  dispose  of  them  to 
his  own  banker  or  get  him  to  make  an  advance  on  them. 

Either  of  these  two  methods  of  financing  our  imports  is 
expensive  even  when  the  time  between  the  shipment  and  the 
receipt  of  the  goods  is  short.  When  the  time  is  much  longer, 
as  in  the  case  of  imports  from  South  America  and  the  Far 
East,  the  cost  is  almost  prohibitive  —  that  is,  so  great  that 
we  can  not  compete  on  an  even  basis  with  foreign  buyers.  In 
fact,  we  might  be  practically  excluded  from  these  markets  if 


702  DEFECTS  OF  OUR  BANKING  SYSTEM 

a  makeshift  were  not  possible.  Our  importer  gets  around  our 
lack  of  banking  facilities  by  having  his  bank  arrange  a  credit 
with  its  London  correspondent.  He  receives  an  undertaking, 
called  a  commercial  letter  of  credit,  giving  the  terms  of  the 
credit  —  that  is,  the  name  of  the  London  bank  upon  which 
the  bills  are  to  be  drawn,  the  amount  which  may  be  drawn,  the 
character  of  the  goods  which  are  to  be  purchased,  the  tenor 
of  the  bills,  and  the  documents  which  must  accompany  them. 
On  the  strength  of  such  a  letter  of  credit,  the  shipper  in  South 
America,  for  example,  is  able  to  dispose  of  his  bills  on  London 
and  thus  receive  immediate  payment  for  his  goods.  The  local 
bank  which  buys  the  bills  sends  them  with  the  documents  to  its 
London  correspondent,  which  presents  the  bills  to  the  bank 
on  which  they  are  drawn  —  that  is,  the  bank  with  which  the 
credit  was  opened.  Upon  the  acceptance  of  the  bills  the  docu- 
ments are  delivered.  They  are  then  sent  by  the  London  ac- 
cepting bank  to  the  New  York  bank  which  opened  the  credit 
and  the  latter  delivers  them  to  the  importer  against  his  trust 
receipt.  Twelve  days  prior  to  the  maturity  of  the  bills  in 
London  the  New  York  bank  presents  a  statement  to  the  im- 
porter indicating  the  amount  of  pounds  sterling  which  must 
be  remitted  to  London  to  provide  for  their  payment  at  ma- 
turity or  rather  a  bill  stated  in  dollars  for  the  amount  of 
pounds  sterling  drawn  under  the  credit.  In  this  purchase  of 
exchange  the  importer  makes  payment  for  his  goods.  This 
method  while  workable  is  obviously  cumbersome,  yet  it  is 
practically  the  only  one  which  the  American  importer  can 
follow  in  connection  with  such  imports.  It  is  expensive  for 
the  importer,  for  not  only  must  he  pay  his  bank  a  commission 
for  arranging  the  credit,  but  there  is  included  in  this  commis- 
sion a  charge  made  by  the  London  bank  for  its  acceptance. 
Further  than  that  the  importer  must  take  a  material  risk  in 
exchange.  At  the  time  a  credit  is  opened  the  cost  of  remit- 
ting, say  £10,000  to  take  up  the  bills  in  London,  might  be  only 
$48.600,  or  at  the  rate  of  $4.86,  whereas  by  the  time  the  bills 
actually  mature  exchange  may  have  risen  and  cost  him  $4.87, 
or  $48,700. 

As  a  result  of  the  inability  of  our  banks  to  finance  imports 
through  the  acceptance  of  time  bills,  American  importers  are, 


NO  SYSTEM  OF  BANK  ACCEPTANCES  703 

then,  made  dependent  to  a  large  extent  upon  London,  and  are 
required  to  pay  London  a  considerable  annual  tribute  in  the 
way  of  acceptance  commissions.  This  practice  not  only  adds 
to  the  importance  of  London  and  militates  against  the  develop- 
ment of  New  York  as  a  financial  center,  but  it  at  the  same 
time  works  serious  injury  to  our  export  trade.  Since  time 
bills  can  not  be  drawn  on  our  banks  from  foreign  points 
against  shipments  of  goods  to  the  United  States,  there  are  con- 
sequently in  such  foreign  countries  very  few  bills  which  can 
be  purchased  for  remittance  to  the  United  States  in  payment 
for  goods  which  have  been  bought  here.  In  other  words, 
under  our  present  banking  system  our  imports  do  not  create 
a  supply  of  exchange  on  New  York,  for  example,  which  can 
be  sold  in  foreign  countries  to  those  who  have  payments  to 
make  in  New  York.  This  means  that  our  exporters  are  also, 
to  their  great  disadvantage,  made  dependent  upon  London. 
It  means  that  when  they  are  shipping  goods  to  South  America 
and  to  the  Orient  they  can  not,  when  they  are  subject  to  com- 
petition, advantageously  bill  them  in  United  States  dollars. 
They  naturally  do  not  care  to  value  their  goods  in  local  cur- 
rency —  that  is,  in  the  money  of  the  country  to  which  the 
goods  are  going  —  so  their  only  alternative  is  to  value  them  in 
francs  or  marks  or  sterling,  preferably  the  latter,  owing  to 
the  distribution  and  extent  of  British  trade,  creating  through- 
out the  world,  as  it  does  under  the  English  banking  system,  a 
fairly  constant  supply  of  and  demand  for  exchange  on  Lon- 
don. When  we  come  to  bill  our  goods  in  sterling,  however,  it 
is  at  once  seen  that  our  exporters  are  obliged  to  take  a  risk  of 
exchange,  which  is  a  serious  handicap  when  competing  with 
British  exporters.  Our  exporters  who  are  to  receive  pay- 
ment for  their  goods  in  sterling  must  previously  decide  on 
what  rate  of  exchange  will  make  the  transaction  profitable. 
If,  in  an  effort  to  safeguard  themselves  against  a  loss  in  ex- 
change, they  calculate  on  too  low  a  rate  for  the  ultimate  con- 
version of  their  sterling  into  dollars,  their  prices  become  un- 
favorable compared  to  those  made  by  British  exporters  and 
they  lose  the  business.  If  they  do  not  calculate  on  a  suffi- 
ciently low  rate  they  get  the  business  but  lose  money  on  the 
transaction  through  a  loss  in  exchange. 


704  DEFECTS  OF  OUR  BANKING  SYSTEM 

The  prohibition  of  bank  acceptances  not  only  acts  as  a 
hamper  upon  our  domestic  and  foreign  trade,  but  is  detri- 
mental to  our  banks  as  well.  It  is  the  small  country  bank 
which  is  chiefly  affected.  The  business  of  the  country  bank, 
so  far  as  the  employment  of  its  funds  is  concerned,  may  be 
divided  into  two  classes  —  that  which  relates  to  advances  to 
local  customers  and  that  connected  with  the  investment  of 
its  surplus.  It  is  in  respect  to  the  latter  that  the  matter  of 
acceptances  is  important.  Under  the  present  limitations  of 
the  National  Bank  Act  there  are  three  principal  ways  in  which 
a  country  bank  may  render  its  surplus  funds  productive.  It 
may  deposit  them  with  its  reserve  agent.  This  means  a  low 
interest  return,  too  low  in  fact  to  permit  of  only  a  relatively 
small  amount  being  thus  employed.  It  may  invest  in  bonds. 
In  this  way  an  increased  interest  return  can  be  secured,  pro- 
viding a  wise  selection  of  securities  is  made,  but  it  partakes 
of  the  nature  of  speculation.  The  third  way  is  to  buy  com- 
mercial paper.  Such  purchases  give  an  ample  interest  return 
and  there  is  no  savor  of  speculation.  Even  this  method  of 
employing  a  bank's  funds,  however,  is  far  from  satisfactory. 
It  means  the  investment  in  a  security  for  the  strength  of 
which  the  bank  must  depend  on  the  word  of  note  brokers,  the 
rating  of  the  mercantile  agencies,  or  the  opinion  of  some  cor- 
respondent bank.  It  means,  furthermore,  the  tying  up  of  the 
bank's  funds  for  a  fixed  period.  If  national  banks  were  per- 
mitted to  accept  time  bills  the  country  bank  could  then  invest 
its  funds  in  paper  bearing  the  guaranty  of  some  great  bank 
with  whose  standing  it  is  perfectly  familiar.  Risk  such  as 
now  has  to  be  taken  would  be  eliminated.  What  is  vital,  how- 
ever, is  that  with  a  national  discount  market  an  investment  in  a 
bank-accepted  bill  is  one  which  could  be  realized  upon  immedi- 
ately. Commercial  paper  and  bank  acceptances  are  both  dis- 
countable. The  prime  difference  between  them,  as  affecting 
a  country  bank,  is  that  they  are  not  both  readily  rediscount- 
able.  Herein  probably  lies  the  reason  for  the  strong  prejudice 
against  rediscounts  which  exists  among  bankers  in  the  United 
States.  In  this  country  when  a  bank  discounts  a  piece  of  com- 
mercial paper  it  is  discounting  something  which  for  its  security 
depends  solely  on  its  maker.  Should  the  bank  desire  to  realize 


NO  SYSTEM  OF  BANK  ACCEPTANCES  705 

on  this  paper  it  could  do  so  by  rediscounting  it,  but  such  a 
rediscount  would  be  practically  equivalent  to  a  loan  to  the 
bank  on  the  strength  of  its  own  name.  In  other  words,  to 
rediscount  its  commercial  paper  would  affect  a  bank's  credit. 
To  ask  for  a  rediscount  is  to  ask  for  accommodation.  This 
would  not  be  the  case  with  bank-accepted  bills.  If  such  bills 
were  discounted  by  a  country  bank  as  a  means  of  investing  its 
surplus  and  it  was  desired  to  realize  on  them  such  a  rediscount 
would  be  made  not  on  the  name  of  the  country  bank,  but  on 
the  name  of  the  accepting  bank.  A  rediscount  in  this  instance 
would  not  constitute  a  loan  to  the  country  bank  and  would 
have  absolutely  no  effect  on  its  credit.  It  would  merely  in- 
dicate that  some  more  profitable  business  had  arisen  in  which 
to  employ  its  funds  or  that  it  was  desirous  of  increasing  its 
reserve. 

Since  the  reserves  of  interior  banks  are  so  largely  concen- 
trated with  them  and  it  is  essential  that  they  keep  their  assets 
in  an  especially  liquid  condition,  the  prohibition  of  bank  ac- 
ceptances works  injury  to  the  banks  at  the  country's  financial 
center,  New  York,  in  a  different  way.  It  deprives  them  of 
what  London  banks,  for  example,  have  —  that  is,  a  mass  of 
the  soundest  securities  against  which  to  loan  their  money  on 
call  or  in  which  they  may  invest  their  funds  for  very  brief 
periods  —  bills  of  exchange,  covering  genuine  commercial 
transactions,  bearing  the  acceptance  of  prime  bankers.  Un- 
questionably such  securities  as  a  basis  for  loans  are  preferable 
to  stock  and  bonds,  but  without  them  New  York  banks  must 
have  recourse  to  day-to-day  loans  on  the  Stock  Exchange. 
Moreover,  when  the  demand  for  such  loans  is  limited.  New 
York  banks  are  forced  into  the  keenest  kind  of  competition,  a 
competition  which,  as  has  been  pointed  out.  is  not  only  of 
little  benefit  to  trade  but  which,  through  the  lowering  of  the 
money  rate,  actually  stimulates  speculation.  Furthermore, 
without  a  steady  money  rate  such  as  exists  in  countries  pos- 
sessing discount  markets,  New  York  banks  are  left  with  no 
reasonable  or  satisfactory  basis  upon  which  to  fix  a  rate  of 
interest  to  pay  for  the  deposits  of  country  banks.  In  London 
interest  on  bank  deposits  is  fixed  at  a  certain  percentage  below 
the  Bank  of  England  discount  rate,  usually  il/2  per  cent. — 


706  DEFECTS  OF  OUR  BANKING  SYSTEM 

that  is,  a  rate  which  fluctuates  with  the  value  of  money  and 
normally  leaves  a  certain  margin  of  profit  to  the  London  bank. 
The  same  practice  is  followed  in  all  the  great  financial  centers 
of  Europe.  With  us,  country  banks  receive  a  fixed  rate  of  in- 
terest for  their  deposits,  usually  2  per  cent.,  the  year  around, 
regardless  of  fluctuations  in  the  value  of  money.  The  un- 
scientific nature  of  such  a  rate  is  obvious.  When  the  call  loan 
rate  is  high  country  banks  do  not  receive  interest  in  proportion 
to  the  value  of  their  deposits.  When  it  is  low  the  New  York 
banks  pay  more  interest  than  the  deposits  are  worth.  In  the 
latter  instance  the  New  York  banks  are  forced  into  injurious 
competition  with  one  another.  They  are  in  much  the  same 
position  as  competing  railroads  were  earlier  in  our  history, 
with  results  similarly  baneful.  With  the  railroads  it  was 
worth  while  to  secure  traffic  even  at  a  losing  rate,  as  no  matter 
what  the  return  it  helped,  if  only  a  little,  toward  meeting  fixed 
charges.  Oftentimes  with  the  New  York  banks  to-day  any 
rate  which  they  can  secure  for  their  money  whether  losing  or 
not  is  acceptable  as  helping  to  meet  this  fixed  interest  charge 
on  bank  deposits.  To  pay  2  per  cent,  for  deposits  and  to 
keep  a  25  per  cent,  reserve  a  bank  must  loan  its  money  at  2^4 
per  cent,  to  come  out  even,  taking  into  consideration  the  actual 
expense  of  making  and  recording  the  transaction.  It  is  better 
to  loan  at  1 24  per  cent.,  however,  than  to  let  the  money  lie  idle. 
It  is  better  to  lose  I  per  cent,  than  to  lose  the  entire  2^4  per 
cent.,  as  would  be  done  in  case  no  loans  at  all  were  made, 
clerk-hire  being  just  as  much  a  fixed  charge  as  interest.  With 
the  amendment  of  the  National  Bank  Act,  to  permit  the  ac- 
ceptance of  time  bills,  such  ruinous  competition  would  cease. 
The  funds  of  the  banks  would  come  to  be  principally  invested 
in  trade  paper  and  stock-exchange  loans  would  be  relegated  to 
a  position  of  secondary  importance,  as  in  London  and  on  the 
Continent.  The  field  for  the  investment  of  their  deposits 
would  be  greatly  broadened,  to  the  benefit  both  of  the  banks 
and  trade  in  general. 

To  remedy  this  primary  defect  in  our  banking  system,  to 
make  possible  the  financing  of  our  domestic  and  foreign  trade 
along  the  lines  which  have  proved  so  advantageous  in  other 
countries,  to  provide  negotiable  paper  of  a  character  suitable 


NO  SYSTEM  OF  BANK  ACCEPTANCES  707 

to  the  investment  of  foreign  funds,  paper  which  can  not  only 
be  discounted  but  rediscounted,  to  give  trade  the  advantage  of 
bank  surpluses  accumulated  both  in  the  country  at  large  and 
in  New  York,  to  lessen  the  evils  of  speculation,  to  afford  a 
reasonable  basis  for  the  calculation  of  interest  rates  on  bank 
deposits  in  central  reserve  cities,  to  bring  New  York  into  the 
circle  of  those  financial  centers  between  which  funds  move 
naturally  as  discount  rates  rise  or  decline,  to  secure  the  ad- 
vantage of  the  competition  of  foreign  capital  for  our  trade 
paper,  can  be  put  in  the  way  of  accomplishment  by  the  inser- 
tion of  a  paragraph  or  two  in  the  National  Bank  Act. 

1  The  European  financial  system  is  constructed  upon  dis- 
counts as  its  foundation;  the  American  system  is  constructed 
upon  bonds  and  stocks  as  its  foundation.  Bank  notes  in  Eu- 
rope are  issued  mainly  against  bullion  and  discounts;  in  the 
United  States  mainly  against  bullion  and  bonds. 

The  quick  assets  held  by  European  banks  against  their  de- 
posits consist  of  discounts  or  call  loans,  largely  secured  by 
discounts.  The  quick  assets  of  American  banks  .  .  .  are  pri- 
marily call  loans  on  stock  and  bond  collateral. 

In  Europe  the  daily  plus  and  minus  of  money  requirements 
are  adjusted  by  the  use  of  the  discount  market  —  that  is  to 
say,  in  a  final  analysis,  by  purchase  or  sale  of  bills.  (Calling 
in  or  putting  out  money  on  call  where  the  loans  are  secured 
by  bills  amounts,  in  effect,  to  a  sale  or  a  purchase  of  bills.) 
In  a  last  analysis  this  means  that  in  Europe  attempts  to  liqui- 
date are  primarily  appeals  to  the  whole  nation  to  liquidate  its 
temporary  commercial  investments,  the  brunt  of  such  liquida- 
tion being  borne  by  the  entire  community,  and  the  pressure 
being  constantly  subdivided,  every  member  of  the  community 
thus  contributing  his  share. 

As  a  majority  of  discounts  represent  goods  in  process  of 
production  or  on  the  way  to  consumption,  liquidation  with 
them  primarily  expresses  itself  by  a  falling  off  in  new  produc- 
tion, while  the  consumer,  on  the  other  hand,  can  not  stop  con- 

1  Paul  M.  Warburg,  The  Discount  System  in  Europe,  Publications  of  the 
National  Monetary  Commission,  Senate  Document,  No.  402,  6ist  Congress, 
2nd  Session,  pp.  23-25. 


708  DEFECTS  OF  OUR  BANKING  SYSTEM 

suming  and  must  therefore  continue  to  pay.  The  brunt  is 
thus  borne  by  the  whole  nation  and  adjustment  follows  with- 
out violent  convulsions. 

In  sharp  contrast  with  such  a  system  the  attempts  to  liqui- 
date in  the  United  States  are  directed  primarily  at  the  con- 
tractors of  stock  exchange  loans.  This  means  that  a  com- 
paratively limited  number  of  debtors  are  called  upon  to  sell 
their  securities.  This  they  can  do  only  by  finding  new  invest- 
ors, who,  as  a  rule,  are  at  such  times  comparatively  rare, 
because  when  acute  pressure  arises  it  generally  originates  in 
the  inability  of  the  investor  to  purchase  because  of  lack  of 
funds  or  in  his  unwillingness  by  reason  of  his  distrust  of  the 
financial  situation.  The  concomitant  of  this  is  that  those 
forced  to  sell  securities  at  such  times  must  offer  them  at  suf- 
ficiently reduced  prices  to  bring  about  an  entire,  change  in  the 
attitude  of  the  investor.  The  difficulty  here  is  that  violent 
reductions  of  prices  in  themselves  cause  distrust,  and  low 
prices  caused  by  distrust  not  only  frighten  away  purchasers 
but.  in  addition,  unsettle  the  owners  of  securities  and  thus 
cause  them  to  join  the  ranks  of  the  sellers.  An  acute  con- 
vulsion, therefore,  must  inevitably  follow  before  the  tide  can 
be  turned.  .  .  . 

Of  course,  general  liquidation  in  Europe  includes  a  liquida- 
tion of  securities,  just  as  liquidation  in  the  United  States  also 
includes  liquidation  of  commercial  paper  as  it  matures.  But 
the  difference  is  that  in  Europe  bills  will  be  the  main  factor 
and  securities  will  play  a  much  more  subordinate  part,  while 
with  us  just  the  reverse  is  true. 

THE  ESSENTIAL  CONDITIONS   FOR  THE  ESTABLISHMENT  OF  AN 
INTERNATIONAL   DISCOUNT    MARKET 

1  The  essential  conditions  for  the  establishment  of  an  inter- 
national discount  market  are : 

i.  Every  bill  offered  for  discount  should  be  based  on  a 
commercial  transaction  where  value  passes.  Finance  or  ac- 

1  Adapted  from  James  H.  Simpson,  General  Manager,  Bank  of  Liverpool, 
Ltd.,  Some  Leading  Features  of  the  London  Money  and  Discount  Markets, 
an  address  delivered  at  the  annual  banquet  of  the  bankers  of  the  city  of 
New  York,  January  19,  1914. 


SUGGESTIONS  OF  AN  ENGLISHMAN  709 

commodation  bills  should  be  extremely  rare  and  capable  of 
satisfactory  explanation. 

2.  It  follows  that  almost  invariably  the  bill  will  arise  out 
of  a  sale  of  goods  and  will  be  in  the  form  of  a  draft  by  the 
seller  upon  the  buyer,  and  accepted  by  the  buyer. 

3.  It  will  thus  be  a  two-name  bill,  and  not  an  individual 
promissory  note.     How  far  you  can  change  your  system  in  this 
respect  and  how  far  the  powers  of  your  new  Federal  banks 
can  be  used  to  induce  such  a  change,  is  a  question  which  I  can- 
not pretend  to  answer,  but  which  you  will  no  doubt  be  able  to 
answer. 

4.  The  bill  should  be  drawn  for  a  period  neither  too  long 
nor  too  short.     The  period  should  be  sufficient  to  allow  of  a 
resale  of  the  goods  on  which  the  bill  is  based,  thus  making  the 
bill  in  a  sense  self-liquidating.     The  usual  period  is  three 
months. 

5.  While  there  should  be  a  large  proportion  of  trade  bills, 
there  should  be  a  still  larger  proportion  of  acceptances  by  banks 
and  finance  houses,   based,   of  course,   on  collateral,   which 
usually  takes  the  form  of  imported  produce.     In  Germany, 
however,  I  understand  that  banks  accept  a  good  many  drafts 
arising  out  of  internal  transactions. 

6.  If  the  market  is  not  to  be  merely  a  home  market,  but 
international ;  that  is,  attractive  to  foreign  bill  buyers,  an  im- 
portant and  desirable  step  would  be  the  opening  of  American 
banks  or  branches  of  American  banks  in  foreign  exchange 
centres,  such  as  London,  Paris,  Berlin,  Amsterdam,  Buenos 
Aires,  Shanghai,  and  so  on,  and  these  banks  should  always  be 
prepared  to  encourage  American  bills  by  buying,  at  reasonable 
rates  of  exchange,  bills  on  New  York,  Chicago,  and  other 
American  centres,  payable  in  dollars. 

7.  Your  usury  laws  would  have  to  be  modified  so  as  to 
allow  discount  rates  to  move  freely  upwards  if  required. 

8.  Your  Federal  reserve  banks  which  are  intended  to  be 
the  equivalent  of  the  Central  banks  of  other  countries,  such  as 
the  Bank  of  England,  Bank  of  France,  and  the  Reichsbank, 
should  be  prepared  to  rediscount  approved  bills  at  all  times  and 
to  any  extent. 

The  advantages  to  you  of  such  a  market  would  be  the  same 


710  DEFECTS  OF  OUR  BANKING  SYSTEM 

advantages  that  we  possess,  namely,  liquid  employment  for 
short  money;  power  to  meet  demands  for  money  without 
disorganizing  stock  exchange  prices ;  power  to  check  over- 
trading at  home,  and  finally,  power  to  check  a  foreign  drain 
of  gold. 

CASH  STOCK  EXCHANGE  DEALINGS 

1  In  England,  France,  and  Germany  there  exist  monthly  or 
half-monthly  settlements  of  stock  exchange  transactions,  and 
as  stock  exchange  loans  run  from  one  settlement  to  the  next 
the  amount  of  money  employed  on  the  stock  exchange  between 
settlements  remains  stationary.  If,  at  the  settlement,  it  de- 
velops that  commitments  on  the  stock  exchange  have  increased 
and  that  a  larger  amount  of  money  is  needed  there,  so  much 
additional  money  will  under  normal  circumstances  be  with- 
drawn from  the  bill  market  and  go  into  the  stock  exchange. 
If  less  money  is  wanted  on  the  stock  exchange,  so  much  more 
will  go  into  the  bill  market. 

Without  entering  upon  a  discussion  of  the  question  of  cash 
stock  exchange  dealings  versus  stock  exchange  dealings  per 
settlement  ( for  which,  be  it  said  in  passing,  a  suitable  method 
of  weekly  stock  exchange  settlements  can  probably  be  devised 
for  this  country,  combined  with  provisions  for  proper  margin- 
ing in  order  to  prevent  over-stimulation  to  gambling) ,  we  are, 
for  the  purposes  of  this  article,  interested  only  in  the  effect 
of  this  method  of  cash  dealings  on  the  whole  financial  system. 
An  exclusive  system  of  cash  dealings  brings  about  the  pre- 
ponderance of  the  call  loan  on  stock  exchange  collateral.  But 
for  the  existence  of  the  seducing  call  loan,  which  is  one  of  the 
gravest  dangers  and  curses  of  our  system,  we  should  have  been 
forced  to  develop  our  bill  market  as  a  regulator  of  our  daily 
money  requirements.  In  that  case,  instead  of  seeing  the  idle 
money  of  the  whole  nation  poured  into  stock  exchange  loans 
when  trade  is  inactive  —  thus  unduly  stimulating  speculation 
when  it  should  be  discouraged  —  and  again  withdrawing 
money  from  the  stock  exchanges  in  order  to  provide  for  the 
business  of  the  whole  nation  when  trade  becomes  active  — 

1  Paul  M.  Warburg,  op.  cit.,  pp.  28-30. 


NO  POWER  TO  LEND  ON  REAL  ESTATE  711 

thus  bringing  about  anxiety  and  convulsions  on  the  stock  ex- 
change in  the  face  of  prosperity  —  we  should  have  a  system 
based  on  bills;  that  is  to  say,  based  on  the  broad  foundations 
consisting  of  the  commerce  and  trade  of  the  whole  nation,  and 
we  should  then  enjoy  an  almost  uniform  rate  of  interest  all 
over  the  country,  gently  rising  and  falling  within  moderate 
bounds,  instead  of  the  violent  fluctuations  and  unbearable  con- 
ditions to  which  we  are  now  subjected. 

The  aggregate  amount  invested  by  a  nation  in  trade  and 
commerce  should  be  and  is  many  times  the  amount  invested 
in  stock  exchange  loans,  which  latter  represent  undigested 
securities  and  securities  carried  for  speculative  investors. 
Our  way  of  doing  business  may  be  illustrated  by  two  adjoin- 
ing reservoirs,  one  small  and  one  very  large.  The  small  one 
represents  the  stock  exchange  and  contains  the  call  loans ;  the 
large  one  represents  the  general  business  of  the  country,  as 
expressed  by  commerce  and  industry.  In  Europe  the  small 
reservoir  is  regulated  by  pumping  water  into  it  from  the  large 
one  or  by  withdrawing  water  from  it  into  the  large  one.  In 
this  way  the  outflow  and  inflow  of  the  large  reservoir  are 
scarcely  perceptible,  and  yet  there  is  no  difficulty  in  regulating 
the  small  one.  With  us,  the  reverse  is  done.  If  there  is  a 
shortage  of  water  in  the  large  reservoir  we  draw  on  the  small 
one  and,  in  order  to  increase  the  water  in  the  large  reservoir 
by  perhaps  an  inch,  we  empty  the  small  one  altogether,  or  else 
in  order  to  decrease  the  amount  of  water  in  the  large  reservoir 
by  an  inch,  we  fill  the  small  one  to  overflowing. 

No  POWER  TO  LEND  ON  REAL  ESTATE  J 

Most  of  the  restrictions  in  the  national  banking  law  have 
to  do  with  loans,  reserves,  or  the  issue  of  notes.  Of  these  the 
restrictions  upon  loans  are  by  far  the  most  serious  impedi- 
ment in  competing  for  business  with  state  banks  and  trust 
companies.  For  the  banks  outside  the  large  cities  this  is  par- 
ticularly true  of  the  provision  which  forbids  loans  upon  real 
estate  as  security. 

1  O.  W.  M.  Sprague,  Banking  Reform  in  the  United  States,  pp.  72-75. 
Harvard  University.  1911. 


DEFECTS  OF  OUR  BANKING  SYSTEM 

This  restriction  is  based  upon  a  sound  banking  principle, 
learned  after  much  bitter  experience.  But  the  experience 
which  led  to  a  complete  prohibition  of  real  estate  loans  was 
gained  amid  the  economic  conditions  of  the  first  half  of  the 
last  century,  and  the  principle  itself  is  one  which  is  applicable 
only  to  a  particular  form  of  banking  organization.  While 
the  country  was  in  process  of  settlement,  with  an  abundance 
of  unoccupied  fertile  land,  real  estate  was  a  security  of  most 
uncertain  value.  Moreover,  the  wildest  of  the  speculative 
movements  which  preceded  all  our  early  crises  were  invariably 
in  land.  At  present,  land  values  are  far  more  stable,  and  real 
estate  is  everywhere  included  among  the  most  conservative 
of  investments,  proper  for  all  with  the  one  exception  of  com- 
mercial banks. 

•For  banks,  all  of  whose  obligations  are  payable  upon  de- 
mand, the  real  estate  loan,  quite  regardless  of  its  safety,  is 
wisely  considered  unsuitable.  Such  loans  are  commonly 
\vanted  by  borrowers  for  a  considerable  period  of  time  and, 
therefore,  they  can  not  readily  be  reduced  in  amount  even  by 
an  individual  bank.  In  other  words,  they  are  not  liquid. 
But  the  importance  of  this  quality  in  all  its  assets  disappears 
when  a  bank  begins  to  acquire  time  or  savings  deposits,  as  well 
as  those  payable  on  demand.  .  .  .  The  example  of  the  trust 
companies  shows  that  a  great  variety  of  financial  business  can 
be  carried  on  safely  and  profitably  under  a  single  manage- 
ment. Failures  among  them  have  been  comparatively  few  in 
number,  and  it  would  be  difficult  to  find  a  single  instance  of 
disaster  which  could  be  attributed  to  the  variety  of  business 
carried  on. 

Some  of  the  advantages  which  the  banks  would  derive  if 
they  were  able  to  lend  on  real  estate  are  so  evident  that  they 
require  little  more  than  mere  mention.  It  would  give  them 
more  of  the  most  profitable  kind  of  business,  that  which  has  its 
origin  in  the  neighborhood  of  the  bank.  The  immediate  re- 
turn is  generally  greater  than  can  be  secured  from  the  employ- 
ment of  funds  in  the  money  centers  or  in  the  purchase  of  paper 
from  note  brokers.  Moreover,  in  fostering  the  growth  of 
wealth  and  population  in  its  locality  a  bank  is  laying  a  solid 
foundation  for  the  future  expansion  of  its  own  business. 


THE  INDEPENDENT  TREASURY         713 

Finally,  the  ability  to  lend  on  real  estate  will  often  enable  a 
bank  to  secure  valuable  customers  who  would  otherwise  go 
elsewhere.  It  has  been  the  unpleasant  experience  of  many  a 
national  banker  to  be  obliged  to  refuse  a  loan  to  a  would-be 
borrower  who  has  nothing  but  real  estate  to  offer  as  security 
and  to  see  him  enter  a  neighboring  state  bank  or  trust  com- 
pany where  there  was  no  legal  obstacle  to  the  transaction. 
Relations  once  established  are  pretty  certain  to  continue  even 
after  the  borrower  has  security  which  falls  within  the  pro- 
visions of  the  national  law. 

There  are  then  at  least  three  distinct  advantages  which  may 
be  expected  to  follow  if  the  national  banks  are  permitted  to 
lend  on  real  estate.  It  would  be  profitable  for  the  banks;  it 
would  be  of  advantage  to  the  localities  served  by  the  banks; 
and,  finally,  it  would  enable  the  banks  to  compete  with  state 
institutions  upon  a  more  equal  footing,1  thus  checking  to  some 
extent  the  relative  decline  of  banking  under  the  national  law. 

THE  INDEPENDENT  TREASURY  AS  A  SOURCE  OF 
WEAKNESS  IN  OUR  BANKING  SYSTEM  2 

For  many  years  the  banks  of  this  country  have  conducted  a 
persistent  agitation  for  the  abolition  of  the  Independent 
Treasury  system.  It  has  been  their  contention  that  the  In- 
dependent Treasury  was  an  archaic  and  inefficient  system  of 
administering  the  finances  of  the  nation ;  that  it  worked  serious 
hardship  upon  the  banks  and  the  business  of  the  country,  and 
that  any  system  of  reform  should  include  its  abolition. 

The  treasury  is,  in  reality,  a  central  bank  of  deposit  with 
branches,  run  by  the  Government,  in  which  the  Government  is 
the  only  depositor,  and  from  which  there  are  no  borrowers. 
The  central  office  of  the  Treasury  is  situated  in  Washington, 
while  there  are  ten  subtreasuries  or  branches  scattered  among 

1  The   importance   of   real   estate  to  the   state  banking  institutions   is 
shown  in  the  Special  Report  from  the  Banks  of  the  United  States  on  April 
28,  1909,  recently  published  by  the  National  Monetary  Commission.     For 
state  banks  real  estate  loans  and  mortgages  amounted  to  $414,000,000  or 
•(2l/2  per  cent,  of  total  resources  and  for  the  trust  companies  to  $377r 
000,000,  more  than  9  per  cent,  of  their  resources. 

2  Conway  and  Patterson,  The  Operation  of  the  New  Bank  Act,  pp.  184- 
192.    J.  B.  Lippincott  Company.     Philadelphia,   1914. 


7H  DEFECTS  OF  OUR  BANKING  SYSTEM 

the  various  large  cities  of  the  country.  The  most  important 
subtreasury,  from  the  standpoint  of  the  volume  of  business 
handled,  is  located  in  New  York  City.  .  .  . 

The  United  States  is  the  only  large  nation  in  the  world  which 
has  a  treasury  system  of  this  sort,  and  this  fact  has  been 
made  much  of  in  the  agitation  for  its  abolition. 

DIFFICULTIES   ARISING   FROM   THE   TREASURY   SYSTEM 

There  is  no  room  for  dispute  that  many  features  of  the 
Independent  Treasury  have,  in  the  past,  been  the  source  of 
serious  difficulties.  However,  we  must  recognize  that  within 
the  last  decade,  and  particularly  within  the  last  two  or  three 
years,  most  of  the  glaring  defects  have  been  eliminated  through 
a  liberalization  in  methods,  involving,  in  brief,  a  deposit  of  a 
very  considerable  amount  of  the  Government's  money  in  na- 
tional banks  rather  than  carrying  it  locked  up  in  the  vaults  of 
the  Treasury,  through  more  liberal  administrative  regulations 
by  which  payments  to  the  Treasury  could  be  made  with  cer- 
tified checks,  and  through  facilitating  in  other  ways  the  trans- 
actions of  business  men  with  the  Treasury  Department. 

CORRESPONDENCE   OF   TREASURY   RECEIPTS   AND 
DISBURSEMENTS 

.  .  .  The  real  criticism  against  the  Treasury  is  that  it  causes 
the  tying  up  of  money,  not  over  a  series  of  years,  but  during 
the  months  in  which  the  banking  system  of  the  country  most 
needs  it.  This  condition  is  the  result  of  the  lack  of  cor- 
respondence between  government  receipts  and  disbursements. 

During  the  first  four  months  of  the  year  the  receipts  are  less 
than  in  any  other  period.  During  the  month  of  May,  the  re- 
ceipts sharply  increase,  reaching  their  maximum  about  the 
first  of  June,  and  continuing  at  a  very  high  rate  over  that 
month.  In  July  the  income  falls  off,  reaching  by  the  end  of 
the  month  a  point  a  little  above  that  which  prevailed  in  April, 
after  which  it  gradually  increases  during  August  and  Sep- 
tember. About  October  first  the  tide  turns  and  the  receipts 
fall  off  sharply  during  that  month,  while  during  December  the 
revenue  again  increases.  As  contrasted  with  this  the  govern- 
ment expenditures  change  only  in  a  general  way.  .  .  . 


THE  INDEPENDENT  TREASURY  715 

EXAGGERATION   OF   TREASURY   EVILS 

It  should  be  stated  that  whatever  embarrassment  exists  be- 
cause of  this  condition,  and  which  as  a  matter  of  fact  has  been 
grossly  exaggerated,  is  found  almost  entirely  in  New  York 
City. 

However,  in  order  to  reduce  as  much  as  possible  the  ob- 
jections raised  by  the  bankers  and  to  prevent  money  being 
taken  out  of  circulation  and  buried  in  the  Treasury,  where  it 
would  be  of  no  service  to  the  country,  the  Secretary  of  the 
Treasury,  on  January  9,  1913,  issued  the  following  order, 
which  inaugurated  a  radical  change  in  the  manner  of  handling 
and  disbursing  the  public  funds.  The  objects  to  be  accom- 
plished were  announced  in  the  order  as  follows : 

"  For  the  purpose  of  bringing  the  ordinary  fiscal  transac- 
tions of  the  Federal  Government  more  nearly  into  harmony 
with  present  business  practices,  it  has  been  determined  that  the 
daily  receipts  of  the  Government  shall  be  placed  with  the  na- 
tional bank  depositaries  to  the  credit  of  the  Treasurer  of  the 
United  States.  Disbursements  will  be  made  by  warrant  or 
check  drawn  on  the  Treasurer,  but  payable  by  national  bank 
depositaries,  as  well  as  by  the  Treasury  and  subtreasuries." 

Secretary  McAdoo,  in  his  report  for  the  fiscal  year  ending 
June  30,  1913,  in  speaking  of  this,  stated  that  while  it  had 
caused  some  embarrassment  "  the  difficulties  at  first  encount- 
ered are  disappearing,  and  the  system  appears  to  respond  to 
the  public  requirements,  and  to  be  accomplishing  the  purposes 
for  which  it  was  devised." 

LACK  OF  CENTRAL  CONTROL 

1  There  is  no  country  in  the  world  where  the  volume  of  cur- 
rency in  circulation  and  the  demand  for  bank  credits  fluctuate 
more  widely  than  in  the  United  States.  This  is  due  to  the 
great  expanse  of  our  territory,  to  the  annual  harvest  require- 
ments of  the  agricultural  sections,  to  the  prevailing  business 
activity  and  enterprise,  and  to  the  rapid  and  unequal  increase 
of  population  and  wealth  in  different  sections.  Furthermore, 

1  Victor  Morawetz,  The  Banking  and  Currency  Problem  in  the  United 
States,  pp.  47-50.     North  American  Review  Publishing  Company.     19x19. 


716  DEFECTS  OF  OUR  BANKING  SYSTEM 

there  is  no  country  in  the  world  where  intelligent  control  over 
bank  credits  and  bank  reserves  is  needed  more  than  in  the 
United  States.  There  are  in  the  United  States  nearly  seven 
thousand  national  banks,  besides  twice,  as  many  state  banks 
and  trust  companies.  Each  of  these  institutions  acts  for  its 
individual  interest  alone,  independently  of  the  others,  and  the 
prevailing  tendency  of  each  at  all  times  is  to  expand  its  credits 
to  the  limit  permitted  by  law.  The  country  banks  lend  their 
surplus  resources  in  the  form  of  deposits  at  interest  to  the 
banks  in  the  larger  cities,  and  the  banks  in  the  principal  money 
centres  commonly  expand  their  credits  as  much  as  practicable 
by  lending  on  call  such  sums  as  they  deem  it  unsafe  to  lend  on 
time  or  by  discount  of  commercial  paper.  Each  bank  with  a 
deposit  in  another  bank  assumes  that,  in  case  of  need,  it  can 
strengthen  its  reserve  by  drawing  upon  this  deposit;  but  it 
fails  to  consider  that,  when  thus  it  strengthens  its  own  re- 
serve, it  must  to  the  same  extent  weaken  the  reserve  of  the 
other  bank,  and  that  the  deposits  of  banks  with  other  banks 
add  no  strength  to  the  general  credit  situation.  Each  bank 
that  has  loaned  money  on  call  assumes  that,  in  case  of  need,  it 
can  strengthen  its  reserve  by  calling  such  loans;  but  it  fails 
to  consider  that,  generally,  when  a  loan  is  called  the  borrower 
is  obliged  to  borrow  the  same  sum  from  some  other  bank, 
although  a  high  rate  of  interest  may  be  exacted,  and,  there- 
fore, that  call  loans  affect  the  security  of  the  entire  bank  situa- 
tion practically  to  the  same  extent  as  time  loans. 

In  the  United  States  there  is  rio  way  of  regulating  the  supply 
of  bank  credits  and  of  holding  part  of  the  potential  supply  in 
reserve  -  for  periods  of  financial  stringency.  Consequently, 
nearly  always  there  is  either  an  over-abundance  of  money 
(meaning  credit  which  the  banks  are  ready  to  lend)  or  a 
money  famine.  It  has  been  argued  that  the  volume  of  credits 
granted  by  the  banks  depends  upon  business  activity  and  upon 
the  consequent  demand  for  credit  and  not  upon  the  power  of 
the  banks  to  grant  credits,  and,  therefore,  that  low  interest 
rates  have  little  effect  in  causing  an  expansion  of  bank  credits. 
Experience,  however,  shows  that  the  contrary  is  the  case,  at 
least  in  the  United  States.  It  is  true  that,  when  there  is  loss 
of  confidence  and  when  business  is  depressed,  interest  rates 


NO  REGULATION  OF  CAPITAL  717 

are  low,  because  there  is  less  currency  in  circulation  and  more 
in  the  bank  reserves,  while  at  the  same  time  the  demand  for 
bank  credits  is  diminished.  It  is  true,  also,  that  low  interest 
rates  will  not  stimulate  speculation  and  enterprise  unless  people 
have  confidence  and  are  ready  to  speculate  and  to  embark  in 
new  enterprises.  But  we  know  by  experience  that  when 
people  are  in  a  mood  for  speculation  and  for  business  ex- 
pansion low  interest  rates  operate  as  a  powerful  stimulus  to 
speculation  and  business  expansion.  A  leading  banker  has 
said :  "  In  the  long  run  commerce  suffers  more  from  the 
periods  of  over-abundance  (of  money)  than  from  those  of 
scarcity.  The  origin  of  each  recurring  period  of  tight  money 
can  be  traced  to  preceding  periods  of  easy  money.  When- 
ever money  becomes  so  over-abundant  that  bankers,  in  order 
to  keep  it  earning  something,  have  to  force  it  out  at  abnormally 
low  rates  of  interest,  the  foundations  are  laid  for  a  period  of 
stringency  in  the  not  far  distant  future,  for  then  speculation 
is  encouraged,  prices  are  inflated,  and  all  sorts  of  securities  are 
floated  until  the  money  market  is  glutted  with  them."  *  [The 
need  of  intelligent  control  over  discount  rates  and  bank  credits 
is  (was)  imperative.] 

ABSENCE  OF  REGULATION  OF  RATIO  OF  DEPOSITS 
TO  CAPITAL  AND  SURPLUS 

2  The  reports  of  condition  of  the  national  banks,  according 
to  the  statements  of  September  12,  1914,  to  the  Comptroller 
of  the  Currency,  show  that,  on  an  average,  the  total  deposits 
of  all  national  banks  amount  to  about  four  and  six-tenths 
times  their  total  capital  and  surplus.  This  means  that  the 
average  capital  and  surplus  of  these  banks  is  equal  to  approxi- 
mately 21  per  cent,  of  the  total  amount  of  deposits.  There 
are,  however,  national  banks  whose  deposits  amount  to  ten  or 
more  times  their  capital  and  surplus,  and  in  these  cases  the 
margin  of  protection  to  depositors  is  only  10  per  cent,  or  less 
of  the  sum  total  of  deposits.  Usually  the  amount  of  money 
which  a  bank  has  invested  in  loans  approximates  the  amount 

1  From  an  address  by  Mr.  James  B.  Forgan  to  the  Texas  Bankers'  As- 
sociation. 

2  Report  of  the  Comptroller  of  the  Currency,  1914,  pp.  20,  21. 


718  DEFECTS  OF  OUR  BANKING  SYSTEM 

of  its  deposits.  In  the  case  of  a  bank  whose  loans  equal  its 
deposits,  and  whose  deposits  are  approximately  ten  times  its 
capital  and  surplus,  it  is  obvious  that  the  loss  of  over  10  per 
cent,  in  loans  would  wipe  out  both  capital  and  surplus  and 
destroy  the  solvency  of  the  bank,  rendering  it  unable  to  pay 
its  depositors. 

The  view  is  held  by  many  practical  bankers  and  experienced 
economists  that  it  is  not  sound  banking  for  an  active  com- 
mercial bank  to  be  allowed  to  receive  deposits  in  excess  of  ten 
times  its  capital  and  surplus.  I  am  firmly  impressed  with  the 
correctness  of  this  view,  and  respectfully  recommend  to  the 
Congress  that  the  national-bank  act  be  amended  so  as  to  pro- 
vide that  no  national  bank  shall  be  permitted  to  hold  deposits 
in  excess  of  ten  times  its  unimpaired  capital  and  surplus. 
Perhaps  it  might  be  wiser  to  make  this  limitation  eight  times 
the  capital  and  surplus. 

Such  a  limitation  need  not  interfere  with  the  growth  and 
development  of  the  bank.  When  its  deposits  approach  an 
amount  equal  to  ten  times  its  capital  and  surplus,  or  whatever 
other  limitation  may  be  fixed,  arrangements  may  be  made  to 
increase  its  capital.  A  bank  whose  deposits  amount  to  ten 
times  the  capital  and  surplus,  if  efficiently  managed,  should  be 
so  profitable  that  there  would  be  no  difficulty  in  providing  for 
an  increase  of  capital  by  the  sale  of  additional  stock,  and  when 
the  proposed  increase  shall  have  been  authorized  by  two- 
thirds  of  its  stockholders  and  approved  by  the  Comptroller  of 
the  Currency,  it  can  be  made  promptly  effective.  A  commer- 
cial bank  whose  capital  and  surplus  amount  to  less  than  one- 
tenth  of  its  deposits  is,  except  possibly  under  very  exceptional 
conditions,  doing  business  on  too  small  a  capital  and  upon  too 
narrow  a  margin  for  safety,  and  does  not  furnish  its  creditors 
the  protection  to  which  they  are  entitled  against  unexpected 
losses  and  contingencies  which  are  liable  to,  and  do,  so  fre- 
quently arise.  .  .  . 

BANKING  ABUSES 

l.  .  .  Among  the  many  abuses  and  violations  of  law  and 
regulations  with  which  the  department  has  to  contend  are  ex- 

1  Ibid.,  pp.  16,  17. 


BANKING  ABUSES  719 

cessive  loans;  overdrafts;  loose  and  unbusinesslike  methods  of 
accounting;  excessive  borrowings  by  the  banks;  investment  of 
the  bank's  funds  in  securities  not  authorized  by  law ;  charging 
of  usurious  rates  of  interest;  unlawful  loans  on  real  estate; 
excessive  loans  to  officers,  clerks,  and  employes  of  the  bank 
employing  them;  loans  to  a  bank's  officers  or  employes  and 
others  through  "dummies";  loaning  money,  directly  or  in- 
directly, upon  the  bank's  own  stock;  transaction  of  a  broker- 
age or  commission  business  by  the  bank's  executive  officers, 
the  commissions  thus  collected  being  sometimes  appropriated 
personally  by  the  officers  and  sometimes  going  directly  or  in- 
directly to  the  bank;  false  statements  of  directors  as  to  owner- 
ship of  stock;  false  statements  made  by  bank  officers,  such  as 
including  as  cash  or  cash  items  memoranda  of  moneys  due 
from  one  source  or  another  which  do  not  represent  actual  cash 
and  can  not  be  immediately  converted  into  cash;  and  failure 
or  refusal  when  so  directed  to  charge  off  bad  debts  and  other 
ascertained  losses;  delay  on  the  part  of  directors  in  taking  the 
oath  of  office. 

For  many  of  the  offences  indicated  the  only  penalty  which 
can  be  enforced  by  the  Comptroller's  office  is  the  forfeiture 
of  the  bank's  charter  by  suit  in  the  United  States  Court.  This 
in  many  cases  would  prove  a  great  hardship  to  innocent  stock- 
holders and  depositors,  and  can  only  be  resorted  to  with  much 
reluctance  by  this  office.  .  .  . 

USURIOUS  INTEREST  RATES 

*A11  the  national  banks  of  the  country  have  been  required  in 
each  report  of  condition  made  to  the  Comptroller's  office  since 
January  i  last  to  state  under  oath  the  highest  rate  of  interest 
they  have  charged  since  the  preceding  report  and  the  average 
rate  of  interest  charged  by  them  on  all  loans  since  the  pre- 
ceding report. 

The  reports  received  at  the  Comptroller's  office  show  indis- 
putably that  in  some  States  and  sections  borrowers,  especially 
small  borrowers,  have  been  and  are  being  subjected  to  extor- 

ijohn  Skelton  Williams,  Address  before  the  Kentucky  Bankers'  As- 
sociation, October  6,  1015,  The  Commercial  and  Financial  Chronicle, 
Vol.  101,  No.  2624,  October  9,  1915,  PP-  U37, 


720  DEFECTS  OF  OUR  BANKING  SYSTEM 

tions  and  exactions  which  the  average  man  would  consider  im- 
possible in  this  enlightened  age. 

One  thousand  and, twenty  banks  in  different  sections  of  the 
country,  out  of  the  total  of  7,615  banks,  admitted  that  they 
were  receiving  an  average  of  10  per  cent,  or  more  —  some  an 
average  of  18  per  cent. —  on  all  their  loans. 

Those  receiving  an  average  of  10  per  cent,  and  upwards 
included  2  banks  in  Illinois,  6  in  Minnesota,  2  in  Missouri,  23 
in  Georgia,  6  in  Florida,  21  in  Alabama,  2  in  Louisiana,  315 
in  Texas,  17  in  Arkansas,  3  in  Tennessee,  90  in  North  Dakota, 
25  in  South  Dakota,  18  in  Nebraska,  5  in  Kansas,  38  in  Mon- 
tana, 14  in  Wyoming,  37  in  Colorado,  25  in  New  Mexico,  300 
in  Oklahoma,  12  in  Washington,  10  in  Oregon,  13  in  Cali- 
fornia, 2  in  Utah,  i  in  Nevada,  and  33  banks  in  Idaho. 

Let  me  illustrate  the  methods  of  some  of  these  bankers  by 
giving  you  the  facts  and  figures  as  taken  from  the  sworn  state- 
ments submitted  to  the  Comptroller's  office  by  the  national 
banks  in  two  particular  States  in  the  Southwest. 

In  one  of  these  States  there  were  131  banks  which  reported 
that  they  charged  a  maximum  rate  of  interest  ranging  from 
1 5  per  cent,  to  24  per  cent,  per  annum,  67  banks  whose  maxi- 
mum rate  ranged  between  25  per  cent,  and  60  per  cent,  per 
annum,  22  banks  which  charged  between  60  per  cent,  per 
annum  and  100  per  cent,  per  annum,  18  banks  whose  maxi- 
mum rate  was  from  100  per  cent,  to  200  per  cent,  per  annum, 
and  8  banks  which  owned  up  to  having  charged  maximum 
rates  ranging  between  200  per  cent,  and  2,000  per  cent. 
Most  of  these  disgraceful  and  unprecedented  rates  were  for 
comparatively  small  loans.  .  .  . 

These  figures  are  not  results  of  the  rule,  applied  by  many 
banks,  not  to  pass  a  loan  on  their  books  for  less  than  a. dollar. 
.  .  .  When  we  find  loans  made  by  national  banks  for  $25, 
$50,  $100,  $200,  $500,  and  $2,000  or  more,  at  40,  50,  100, 
or  1,000  per  cent.,  it  is  merely  a  hideous  gamble  on  how  long 
the  borrower  can  keep  starvation  from  his  door  and  live  and 
work.  Yet  I  am  told  on  good  authority  that  in  one  State, 
largely  agricultural,  reports  from  nearly  200  banks  —  lending 
chiefly  or  largely  to  farmers  —  show  losses  of  only  a  fraction 
of  i  per  cent,  on  farmers'  loans,  while  the  average  interest 


USURIOUS  INTEREST  RATES          721 

rate  in  these  particular  banks  is  12  per  cent,  to  15  per  cent— 
and  the  maximum  rate  30  per  cent,  or  40  per  cent.,  the  banks 
paying  large  dividends. 

We  read  much  of  the  infernos  of  the  slums  of  the  great 
cities,  of  degradation  and  misery  and  squalor,  of  the  grind- 
ing callousness  of  tenement  landlords  and  sweatshop  operators. 
Here  in  the  country  we  find  bankers,  men  in  business  that 
should  be  the  most  respectable,  as  it  is  the  most  responsible, 
of  all  secular  avocations,  literally  crushing  the  faces  of  their 
neighbors,  deliberately  fastening  their  fangs  in  the  very 
heart  of  poverty.  .  .  . 

A  well  thought  out,  carefully  constructed,  conservative  sys- 
tem of  rural  credits  for  the  development  of  agriculture  and 
the  increase  of  our  wealth  and  resources  by  offering  en- 
couragement and  opportunity  to  the  ambitious  farmer  will 
come  presently.  When  it  comes  all  of  us  will  share  the  splen- 
did results. 


BANKERS     VIEW    OF   USURIOUS   INTEREST   RATES 

1  On  February  25  the  following  statement  was  "  given  out " 
from  the  office  of  the  Comptroller  of  the  Currency : 

The  Comptroller  of  the  Currency  received  to-day  from  the  Farmers' 
Grain  Dealers'  Association  of  Iowa  notification  of  the  adoption  at 
the  convention  of  that  association  in  Des  Moines,  Iowa,  on  the 
I7th  instant,  of  the  following  resolution: 

Be  It  Resolved,  By  the  Farmers'  Grain  Dealers'  Association  of 
Iowa,  representing  40,000  members,  as  follows: 

That  we  are  as  much  opposed  to  bank  discrimination  in  interest 
rates  as  to  railroad  discrimination  in  freight  rates. 

We  oppose  private  control  of  the  public  currency. 

That  we  strongly  commend  the  Comptroller  of  the  Currency  for 
his  courageous  exposure  of  bank  usury;  and  we  unalterably  oppose 
the  efforts  of  the  guilty  parties  to  abolish  his  office. 

There  has  been  no  better  statement  of  the  Comptroller's 
position  than  is  here  given  —  credit  standing  and  variations 
of  it  must  have  no  influence  on  interest  rates  and  anyone  who 

1  Journal  of  the  American  Bankers?  Association,  Vol.  VIII,  No.  9,  March, 
1916,  pp.  755-6. 


722  DEFECTS  OF  OUR  BANKING  SYSTEM 

wishes  his  office  abolished  is  guilty  of  usury;  or,  conversely, 
only  those  guilty  of  usury  wish  the  office  abolished. 

The  statement  is  inadequate  only  in  the  failure  to  define 
what  is  meant  by  "  private  control  of  the  public  currency." 


CHAPTER  XXXI 

THE  FEDERAL  RESERVE  SYSTEM 
THE  FEDERAL  RESERVE  AcT1 

THE    SPIRIT    AND    OBJECTS    OF   THE   ACT 

THE  primary  purpose  of  the  Federal  Reserve  Act  of  De- 
cember 23,  1913,  is  to  make  certain  that  there  will  always  be 
an  available  supply  of  money  and  credit  in  this  country  with 
which  to  meet  unusual  banking  requirements.  Banks  of  a 
new  class,  to  be  known  as  Federal  Reserve  Banks,  are  to  be 
established,  and  upon  these  banks  is  to  rest  the  heavy  re- 
sponsibility of  supporting  the  structure  of  credit  in  periods  of 
financial  strain.  The  new  banks  are  expected  to  keep  them- 
selves in  a  condition  of  such  strength  in  ordinary  times  that 
the  other  banks  may  safely  rely  upon  them  for  all  needed  cash 
and  credit  in  emergencies.  In  the  past,  the  banks  in  this  coun- 
try, when  subjected  to  financial  pressure,  have  relied  mainly 
upon  loan  contraction  and  the  selling  of  securities.  In  future  it 
is  expected  that  they  will  resort  to  the  Federal  Reserve  Banks, 
securing  additional  funds  from  these  by  rediscounting  com- 
mercial loans.  If  the  new  arrangements  work  well,  loans  in 
future  will  not  be  reduced  merely  for  the  purpose  of  strength- 
ening the  banks.  Loan  contraction  will  take  place  only  when 
there  is  evidence  of  an  over-extended  condition  of  business; 
and  even  then  contraction  will  be  carried  through  gradually, 
so  as  to  conserve  all  interests  so  far  as  may  be  possible.  Under 
the  new  system  a  most  important  influence,  if  not  the  most 
important  single  influence  determining  the  character  of  bank- 
ing operations,  will  be  just  the  reverse  of  what  it  has  been  in 
the  past 

To  meet  the  heavy  responsibilities  placed  upon  the  Federal 

1  O.  M.  W.  Sprague,  The  Federal  Reserve  Act  of  1913,  The  Quarterly 
Journal  of  Economics,  Vol.  28,  No.  2,  February,  1914,  pp.  213-254. 

723 


724         THE  FEDERAL  RESERVE  SYSTEM 

Reserve  Banks,  two  things  are  absolutely  essential  —  good 
management,  and  ample  powers  and  resources.  Good  manage- 
ment cannot  be  secured  with  certainty  by  means  of  legislative 
provisions,  however  carefully  designed  with  that  end  in  view. 
In  the  particular  instance  of  the  Federal  Reserve  Act,  an  in- 
genious combination  of  government  and  banking  influence  in 
selecting  the  management  is  provided.  Purely  banking  opera- 
tions are  very  largely  to  be  handled  by  boards  of  directors,  a 
majority  of  the  membership  of  which  is  to  be  chosen  by  banks. 
General  supervision,  and  for  some  purposes  control,  is  placed 
with  the  Federal  Reserve  Board,  which  is  to  be  appointed  by 
the  President  of  the  United  States,  by  and  with  the  advice  and 
consent  of  the  Senate.  Experience  alone  can  determine  the 
wisdom  of  these  arrangements  for  securing  effective  manage- 
ment. 

The  Federal  Reserve  Banks  are  to  exercise  wide  powers,  and 
would  seem  likely  to  have  ample  resources.  The  country  is 
to  be  divided  into  not  less  than  eight,  nor  more  than  twelve 
districts,  in  each  of  which  a  federal  reserve  bank  is  to  be  estab- 
lished.1 All  national  banks  are  required,  and  qualified  state 
banking  institutions  are  invited,  to  subscribe  to  the  capital  of 
the  reserve  bank  in  their  district.  Subscribing  banks,  to  be 
known  as  member  banks,  are  required  to  keep  a  part  of  their 
reserve  with  their  Federal  Reserve  Bank.  These  banks  will 
presumably  receive  most  if  not  all  of  the  general  funds  of  the 
United  States  Government.  They  will  provide  an  elastic  cur- 
rency, issuing  notes  secured  by  their  commercial  assets.  They 
are  also  empowered  to  undertake  the  business  of  collecting 
and  clearing  checks  throughout  the  entire  country,  thus  pro- 
viding an  organization  for  making  settlements  between  banks 
in  different  places,  the  lack  of  which  has  been  one  of  the  most 
serious  defects  in  our  banking  system. 

Each  Federal  Reserve  Bank  will  be  a  central  bank  for  the 
section  of  the  country  which  it  is  to  serve.  It  will  have  all 
the  responsibilities  and  most  of  the  powers  of  central  banks 
in  the  various  European  countries;  but  largely  because  the 
system  is  to  be  superimposed  upon  a  fully  developed  banking 

1  [The  country  has  been  divided  into  twelve  districts  in  each  of  which 
a  Federal  Reserve  Bank  began  operations  November  16,  1914.! 


THE  FEDERAL  RESERVE  ACT          72"$ 

system,  some  important  provisions  of  the  Federal  Reserve  Act 
are  unlike  anything  to  be  found  in  European  legislation.  The 
Federal  Reserve  Banks  are  to  receive  deposits  from  the  Govern- 
ment and  from  member  banks  only.  Ordinarily  they  will  lend 
to  member  banks  only.  All  European  central  banks,  though 
the  bulk  of  their  business  is  with  banks  and  bankers,  may  deal 
with  the  general  public  and  do  so.  The  most  striking  diverg- 
ence from  European  example,  however,  is  the  really  novel 
plan  of  a  system  of  regional  banks  in  place  of  a  single  central 
bank.  But  the  extent  of  this  divergence  is  generally  exag- 
gerated. Political  boundaries  are  indeed  in  large  measure 
economic  arid  financial  boundaries  as  well;  but  central  banks 
in  the  European  countries  do  act  and  react  upon  each  other, 
often  working  in  harmony,  and  yet  at  times  very  much  at  cross 
purposes.  If  all  Europe  were  brought  under  a  single  govern- 
ment, very  likely  the  various  existing  central  banks  would  be 
merged  into  a  single  institution.  In  some  respects  this  would 
be  advantageous,  but  it  would  not  be  absolutely  necessary. 
Certainly  European  arrangements  are  not  so  fundamentally 
unlike  those  of  a  system  of  regional  banks  in  a  single  country 
of  great  size,  as  to  afford  ground  for  the  opinion  that  in 
setting  up  this  system  foreign  experience  has  been  altogether 
disregarded. 

The  various  considerations  which  led  to  the  adoption  of  the 
plan  for  regional  banks,  rather  than  a  single  central  institu- 
tion, deserve  careful  attention,  since  they  indicate  the  spirit 
and  purpose  of  the  Federal  Reserve  Act.  A  single  central 
bank  was  the  solution  of  the  banking  problem  reached  without 
a  dissenting  voice  by  the  members  of  the  National  Monetary 
Commission.  The  bill  which  the  commission  prepared  was  a 
notable  achievement.  Pioneer  work  though  much  of  it  neces- 
sarily was,  very  few  defects  on  the  technical  banking  side  were 
disclosed  in  the  discussion  which  followed  the  statement  of  the 
proposed  measure.  Its  provisions  regarding  banking  opera- 
tions, including  relations  with  other  banks,  are  embodied  with 
few  changes  of  an  essential  character  in  the  Federal  Reserve 
Act.  Most  of  the  important  differences  between  the  bill  and 
the  Federal  Reserve  Act  reflect  differences  in  spirit  and  pur- 
pose rather  than  in  methods.  A  central  bank  and  also  the 


726        THE  FEDERAL  RESERVE  SYSTEM 

system  of  regional  banks  necessarily  involve  placing  some- 
where very  extensive  power  to  influence  and  control  credit. 
In  the  present  temper  of  public  opinion,  the  possession  of 
great  economic  power  is  not  tolerated  in  the  absence  of  a  large 
measure  of  government  supervision  and  control.  But  un- 
fortunately, in  framing  its  measure  the  monetary  commission 
failed  to  realize  the  fundamental  importance  of  this  considera- 
tion as  a  factor  in  securing  general  public  approval.  In  de- 
vising a  form  of  organization,  competent  management  and  ap- 
proval in  banking  circles  were  evidently  the  controlling  factors. 
An  organization  was  proposed  under  which  out  of  forty-five 
directors,  but  three  were  to  represent  the  Government,  the  re- 
mainder being  selected  in  various  ways  by  bankers.  Support 
from  some  who  were  the  most  bitter  opponents  of  the  measure 
might  have  been  secured  if  the  bill  had  provided  for  a  larger 
measure  of  government  control ;  but  an  equal  or  even  greater 
number  of  adherents  would  probably  have  been  lost.  Under 
the  plan  of  the  commission  and  indeed  under  any  central  bank 
plan,  government  supervision  and  control  cannot  be  made  ef- 
fective without  at  the  same  time  placing  the  details  of  opera- 
tion in  charge  of  government  officials.  Few  of  the  most  ar- 
dent advocates  of  a  central  bank  were  prepared  to  take  this 
extreme  step. 

Under  the  plan  of  organization  of  regional  banks,  the  diffi- 
culty of  combining  government  control  and  private  manage- 
ment vanished.  Purely  banking  matters,  such  as  the  granting 
of  loans,  could  be  placed  with  boards  entirely  or  mainly  com- 
posed of  persons  selected  by  the  bankers  whose  funds  were  to 
provide  most  of  the  necessary  resources.  On  the  other  hand, 
supervision  and  whatever  measure  of  control  might  be  deemed 
advisable,  could  be  placed  with  a  board  mainly  or  entirely  ap- 
pointed by  the  President  of  the  United  States.  Differences 
of  opinion  may  be  entertained  regarding  the  particular  ar- 
rangements in  the  Federal  Reserve  Act  for  selecting  the  vari- 
ous administrative  bodies,  and  regarding  the  division  of  power 
between  the  directorates  of  the  federal  reserve  banks  and  the 
Federal  Reserve  Board.  If  experience  should  disclose  defects 
in  this  form  of  organization,  it  is  flexible  enough  to  permit  at 
any  time  an  extension  of  government  or  of  banking  influence. 


THE  FEDERAL  RESERVE  ACT          727 

Another  important  advantage  of  the  regional  system  is  to 
be  noted.  The  operation  of  a  central  bank  would  be  far  more 
likely  to  give  rise  to  sectional  antagonism.  This  danger  was 
apparently  fully  realized  by  the  members  of  the  National 
Monetary  Commission,  and  elaborate  arrangements  for  select- 
ing the  management  were  devised  in  order  to  make  certain 
that  each  section  of  the  country  should  be  properly  represented. 
But  obviously  regional  banks,  managed  by  local  people,  are 
very  much  more  certain  to  meet  this  requirement.  Apparently 
it  was  an  endeavor  to  remove  still  further  the  danger  of  sec- 
tional dissatisfaction  that  led  the  Monetary  Commission  to 
make  its  one  serious  departure  from  sound  banking  principle 
in  framing  its  bill.  A  provision  was  inserted  requiring  redis- 
counts to  be  made  at  a  uniform  rate  throughout  the  entire 
country,  regardless  of  the  wide  differences  in  the  demand  and 
supply  of  capital,  which  occasion  the  existing  wide  differences 
in  lending  rates.  Under  the  regional  plan  no  such  indefensible 
provision  was  found  necessary.  This  important  feature  of 
the  Federal  Reserve  Act  outweighs  such  advantages  in  econ- 
omy of  resources  and  effectiveness  in  management  as  were 
sacrificed  in  substituting  for  a  central  bank  the  regional  banks. 

The  Monetary  Commission  in  framing  its  bill  seems  to  have 
been  guided  by  two  principles  generally  wise  in  legislation  — 
the  scope  of  the  measure  was  limited  to  the  single  purpose  of 
removing  purely  banking  defects  in  our  banking  system,  and 
no  greater  departure  from  existing  arrangements  was  pro- 
posed than  was  essential  for  the  purpose  in  hand.  The  Fed- 
eral Reserve  Act  certainly  runs  counter  to  the  first  of  these 
principles.  Its  primary  purpose  is  similar  to  that  of  the  bill 
of  the  monetary  commission;  but  a  secondary  purpose  evi- 
dently exercised  a  potent  influence.  This  purpose  was  to  de- 
centralize credits  by  lessening  the  concentration  of  banking 
funds  in  a  few  large  banks  in  the  chief  financial  centers,  and 
especially  in  New  York.  The  regional  system  itself  gained 
much  support  because  it  was  believed  by  many  that  it  would 
lessen  the  financial  predominance  of  New  York  City.  No 
comprehensive  scheme  of  legislation  with  this  object  in  view 
was  inserted  in  the  bill ;  but  wherever  two  or  more  means  of 
accomplishing  the  primary  purpose  of  the  bill  were  open,  that 


728         THE  FEDERAL  RESERVE  SYSTEM 

one  was  evidently  selected  which  it  was  believed  might  tend 
toward  decentralization.  In  general  the  desire  to  decentralize 
credits  explains  why  the  act  makes  very  much  greater  changes 
in  existing  arrangements  than  were  proposed  in  the  bill  of  the 
Monetary  Commission.  In  the  latter,  the  practice  of  deposit- 
ing a  part  of  the  required  reserves  of  the  banks  with  reserve 
agents  was  left  undisturbed.  Under  the  terms  of  the  Federal 
Reserve  Act,  such  deposits  are  to  be  reduced  by  successive 
installments,  and  discontinued  entirely  three  years  after  the 
passage  of  the  act.  From  a  purely  banking  point  of  view, 
much  can  be  said  for  this  great  change;  but  it  was  certainly 
not  absolutely  necessary  in  order  to  secure  the  desired  improve- 
ments in  the  working  of  our  banking  system. 

The  new  banking  institutions  for  which  the  Federal  Reserve 
Act  makes  provision  cannot  be  put  in  successful  operation 
(and  in  this  it  resembles  the  bill  of  the  Monetary  Commission) 
unless  a  considerable  number  of  the  existing  banks  enter  into 
relations  with  them.  An  institution  might  have  been  estab- 
lished with  large  capital,  and  a  monopoly  of  the  right  of  note 
issue,  authorized  to  act  as  government  fiscal  agent,  and  to 
deal  with  the  general  public.  Such  an  institution  would  pre- 
sumably in  the  course  of  time  have  become  a  central  bank, 
the  main  reliance  of  other  banks  in  emergencies.  In  order  to 
avoid  competition  with  existing  banks,  the  act  provides  that 
the  receipt  of  deposits  by  the  Federal  Reserve  Banks,  and  their 
normal  lending  operations  shall  be  confined  to  those  banks 
which  subscribe  to  the  capital  and  maintain  balances  with 
them.  Obviously,  then,  if  banks  in  large  numbers  do  not  ac- 
cept the  arrangement,  subscribing  to  the  capital  and  relying 
upon  the  new  banks  for  accommodation,  the  system  cannot  be 
put  into  effective  operation.  Moreover,  it  is  necessary  that 
many  banks  shall  enter  the  system  at  the  outset.  An  attitude 
of  hesitation  would  change  to  one  of  positive  distrust,  if  the 
initial  response  were  inadequate. 

In  the  case  of  the  bill  of  the  Monetary  Commission,  reliance 
was  placed  simply  upon  the  attractiveness  of  the  measure. 
No  bank  would  have  suffered  positive  loss  from  failure  to 
enter  the  system,  though  certain  slight  inducements  were  held 
out  to  those  banks  which  accepted  the  arrangement  at  the  out- 


THE  FEDERAL  RESERVE  ACT          729 

set.  Whether  a  sufficient  number  of  banks  would  have  en- 
tered that  system,  if  it  had  been  established,  may  be  thought 
probable  but  is  not  certain.  Bankers  are  naturally  and  prop- 
erly a  conservative  class  and  the  inclination  of  many  would 
have  been  to  wait  until  the  system  was  in  successful  operation. 
The  attitude  of  bankers  toward  the  Federal  Reserve  Act  while 
it  was  passing  through  Congress  was  distinctly  unfavorable. 
Most  of  its  provisions  already  referred  to,  as  well  as  others  in 
which  it  differed  from  the  Monetary  Commission  bill,  were 
disliked.  It  was  evident  that  in  the  absence  of  positive  pres- 
sure, the  number  of  banks  which  would  accept  its  terms  would 
be  too  small  to  make  successful  operation  possible.  No  at- 
tempt was  made,  however,  to  insert  provisions  which  would 
bring  pressure  upon  state  banking  institutions.  Perhaps  it 
would  be  possible,  either  under  the  inter-state  commerce  or  the 
postal  clause  in  the  Constitution;  but  it  would  have  been  con- 
trary to  the  constitutional  traditions  of  the  party  in  power,  and 
it  was  not  necessary.  If  the  national  banks  very  generally 
enter  the  system,  the  resources  of  the  Federal  Reserve  Banks 
will  be  sufficient  to  test  the  effectiveness  of  the  measure.  Ac- 
cordingly the  Federal  Reserve  Act  contains  a  number  of  pro- 
visions designed  to  bring  pressure  to  bear  upon  these  to  enter 
the  system  immediately.  Failure  to  accept  the  terms  of  the 
act  within  one  year  after  its  passage  involves  forfeiture  of  the 
national  charter.  This  alone  would  be  no  great  business  sacri- 
fice, since  banking  in  most  States  is  quite  as  profitable  undei 
a  state  as  under  a  national  charter.  Loss  of  the  national 
charter,  however,  involves  a  loss  of  the  right  to  issue  bank 
notes  and  calls  for  the  deposit  of  lawful  money  in  Washington 
equivalent  to  the  amount  of  outstanding  circulation.  Most 
national  bank  notes  are  secured  by  2  per  cent,  government 
bonds,  the  price  of  which,  in  the  absence  of  the  circulation 
privilege,  would  be  perhaps  about  two-thirds  of  the  price 
(somewhat  above  par)  at  which  they  were  purchased  by  the 
banks.  No  considerable  number  of  national  banks  could  re- 
fuse to  enter  the  system  without  involving  themselves  in  a 
heavy  immediate  loss.  A  further  provision  in  the  act  puts 
more  immediate  pressure  upon  the  national  banks  in  reserve 
cities.  If  within  sixty  days  after  the  passage  of  the  act,  a 


730         THE  FEDERAL  RESERVE  SYSTEM 

reserve  agent  bank  fails  to  signify  acceptance  of  its  terms,  it 
must  cease  to  exercise  the  reserve-holding  right  upon  thirty 
days'  notice  from  the  Federal  Reserve  Board. 

Many  bankers  bitterly  condemned  the  compulsory  features 
in  the  act  while  it  was  on  its  passage  through  Congress.  This 
feeling  was  perfectly  natural,  but  it  was  not  very  generally 
shared  outside  banking  circles.  Impartially  considered,  the 
act  imposes  no  unreasonable  burden  upon  those  who  have  in- 
vested capital  in  national  banks.  No  one  fears  the  loss  of  the 
funds  which  may  be  subscribed  to  the  capital  stock  of  the  fed- 
eral reserve  banks  or  placed  on  deposit  with  them.  If  loss 
should  be  incurred,  it  would  be  primarily  due  to  unsound 
banking  on  the  part  of  the  boards  of  directors  of  the  Reserve 
Banks,  a  majority  of  the  membership  of  which  is  to  be  chosen 
by  the  banks  themselves.  Some  bankers  have  doubted 
whether  the  act  would  prove  an  effective  measure  of  banking 
reform;  but  few  if  any  have  felt  that  results  under  its  opera- 
tion could  possibly  be  more  unsatisfactory  than  those  under 
the  present  system ;  and  all  agree  that  it  is  a  long  step  toward  a 
perfected  system. 

ORGANIZATION 

The  new  system  is  to  be  organized  under  the  supervision 
and  direction  of  the  "  Reserve  Bank  Organization  Commit- 
tee," consisting  of  the  Secretary  of  the  Treasury,  the  Secretary 
of  Agriculture,  and  the  Comptroller  of  the  Currency.  The 
most  important  function  of  this  committee  is  to  determine, 
"  with  due  regard  to  the  convenience  and  the  customary  course 
of  business,"  the  number  and  area  of  the  Federal  Reserve  dis- 
tricts into  which  the  country  is  to  be  divided,  and  to  designate 
the  city  in  each  district  in  which  a  Federal  Reserve  Bank  is  to 
be  established.  Not  less  than  eight,  nor  more  than  twelve  dis- 
tricts are  to  be  created.  This  is  a  most  difficult  task.  How- 
ever carefully  the  initial  lines  of  demarcation  may  be  drawn, 
more  or  less  modification  is  to  be  expected  after  there  has  been 
some  experience  with  the  working  of  the  system.  Changes  in 
area  of  districts,  and  additional  districts  if  the  organization 
committee  designates  less  than  twelve,  may  be  made  at  any 
time  in  the  future  by  the  Federal  Reserve  Board.  While  the 


THE  FEDERAL  RESERVE  ACT  731 

rivalry  of  cities  may  tempt  the  committee  to  start  the  system 
with  a  larger  number,  it  is  to  be  hoped  that  it  will  be  found 
feasible  to  begin  with  no  more  than  eight  or  nine  districts. 
The  problems  which  will  confront  the  management  of  the 
Federal  Reserve  Banks  are  in  many  respects  unlike  those  with 
which  our  bankers  have  had  experience.  A  somewhat  higher 
average  of  capacity  in  the  management  may  more  confidently 
be  looked  for  if  the  smaller  number  of  banks  is  established. 
Moreover,  especially  at  the  outset,  mere  size  will  contribute 
not  a  little  to  the  prestige  of  the  banks,  and  so  inspire  public 
confidence  in  the  new  system.  A  greater  variety  of  occupa- 
tions in  large  areas  will  lessen,  though  not  much,  extremes  of 
seasonal  variation  in  demands  for  accommodation  upon  the 
federal  reserve  banks.  Then,  too,  the  task  of  the  Federal 
Reserve  Board  in  supervising  and  co-ordinating  the  system 
will  be  materially  simplified,  if  the  minimum  rather  than  the 
maximum  number  of  federal  districts  is  decided  upon. 

Within  sixty  days  after  the  passage  of  the  act,  in  other 
words  before  February  22,  1914,  national  banks  are  required, 
and  properly  qualified  state  banks  are  invited,  to  signify  their 
acceptance  of  the  terms  of  the  act.  Within  thirty  days  after 
the  reserve  districts  have  been  designated,  each  national  bank 
must  subscribe  to  the  capital  of  the  reserve  bank  of  its  district 
an  amount  equal  to  6  per  cent,  of  its  capital  and  surplus. 
One-sixth  of  this  subscription  is  to  be  paid  at  the  call  of  the 
organization  committee,  another  sixth  within  three  months, 
and  still  another  within  six  months  thereafter.  The  remain- 
ing half  of  the  subscription  may  be  called  at  any  time  by  the 
Federal  Reserve  Board.  All  these  payments  are  to  be  made  in 
gold  or  in  gold  certificates.  It  will  be  observed  that  the  exact 
time  when  the  system  will  be  established  is  uncertain.  The 
organization  committee  is  only  required  to  designate  the  re- 
serve districts  as  soon  as  is  practicable;  thirty  days  is  then 
allowed  for  the  banks  to  subscribe;  and  payments  will  begin 
sometime  thereafter  at  the  call  of  the  committee.  .  .  . 

After  the  minimum  capital  (four  million  dollars  for  any 
federal  reserve  bank)  has  been  subscribed,  the  certificate  of 
organization  is  to  be  executed  by  any  five  member  banks 
designated  for  the  purpose  by  the  organization  committee. 


732  THE  FEDERAL  RESERVE  SYSTEM 

The  final  duty  of  the  committee  will  be  to  supervise  all  ar- 
rangements for  the  election  of  the  six  of  the  nine  directors 
of  each  Federal  Reserve  Bank,  who  are  to  be  chosen  by  the 
member  banks.  For  electoral  purposes  the  banks  of  each 
district  are  to  be  divided  into  three  groups  —  each  group  to 
"  contain  as  nearly  as  may  be  one-third  of  the  aggregate  num- 
ber of  the  member  banks  .  .  .  and  as  nearly  as  may  be  banks 
of  similar  capitalization."  While  the  number  of  banks  in 
each  group  will  be  the  same,  the  capitalization  will  be  ver} 
different.  All  the  banks  with  a  capitalization  above  the  a\<r- 
age  in  a  district  will  certainly  be  in  one  group ;  those  of  some- 
what less  than  average  capital,  in  the  second  group ;  while  the 
third  group  will  be  composed  of  banks  having  a  very  small 
capitalization.  Under  this  ingenious  arrangement,  it  is  evi- 
dent that  the  direct  influence  of  the  banks  of  the  large  cities 
in  selecting  the  directorates  of  the  Federal  Reserve  Banks  is 
limited.  Local  alignments  are  also  avoided.  On  the  other 
hand,  this  is  not  a  grouping  to  which  the  banks  have  been 
accustomed  in  the  past,  and  therefore  there  is  some  uncer- 
tainty as  to  whether  at  the  outset  it  will  be  conducive  to  the 
selection  of  capable  directorates. 

Each  group  of  banks  is  to  choose  two  directors :  a  Class  A 
director,  who  is  to  be  an  active  banker  representing  the  stock- 
holding banks,  and  a  Class  B  director,  who  must  be  actively 
engaged  in  commerce,  agriculture,  or  some  other  industrial 
pursuit  in  his  district.  The  board  of  directors  of  each  mem- 
ber bank  is  to  elect  a  district  reserve  elector.  Candidates  for 
the  position  of  director  of  a  Federal  Reserve  Bank  may  be 
nominated  by  any  member  bank ;  but  nomination  is  not  neces- 
sary. Electors  are  to  signify  their  first,  second,  and  other 
choices  for  one  director  in  each  class  on  a  preferential  ballot. 

In  addition  to  the  six  directors  chosen  by  the  banks,  three 
directors  (Class  C)  are  to  be  appointed  by  the  Federal  Reserve 
Board.  Two  of  these  must  be  persons  of  "  tested  banking 
experience,"  one  to  serve  as  chairman  of  the  board  of  directors 
and  district  reserve  agent,  the  other  as  deputy  chairman  and 
deputy  reserve  agent.  These  reserve  agents  are  the  official 
representatives  of  the  Reserve  Board,  through  whom  it  will 
exercise  its  powers  of  supervision  and  control  over  the  reserve 


.   THE  FEDERAL  RESERVE  ACT  733 

banks.  The  act  contains  no  provision  regarding  the  officers 
to  whom  the  operation  of  the  banks  will  be  entrusted.  Pre- 
sumably each  board  of  directors  will  appoint  one  of  its  mem- 
bers (probably  one  of  the  Class  A  directors)  as  president  and 
manager.  The  term  of  office  of  all  directors  is  three  years, 
but  at  the  outset  they  are  to  be  classified  so  that  the  term  of 
one  director  of  each  of  the  three  classes  shall  expire  annually. 
The  appointment  of  Class  C  directors  will  be  the  first  duty 
of  the  Federal  Reserve  Board ;  inasmuch  as  the  organization 
of  the  system  can  hardly  be  completed  before  the  beginning  of 
the  summer,  the  appointment  of  this  board  could  be  deferred 
until  that  time.  The  selection  of  these  directors  for  each  of 
the  eight  or  more  Federal  Reserve  Banks  is,  however,  no  small 
task  in  itself;  and  since  public  confidence  in  the  new  system 
will  largely  be  based  at  the  outset  upon  the  character  of  the 
Federal  Reserve  Board,  its  early  selection  is  much  to  be  de- 
sired. 

The  Federal  Reserve  Board  itself  is  to  consist  of  seven 
members :  the  Secretary  of  the  Treasury  and  Comptroller  of 
the  Currency  ex  officio,  and  five  members  appointed  by  the 
President  of  the  United  States  by  and  with  the  [advice  and] 
consent  of  the  Senate.  Of  the  five  appointed  members,  at 
least  two  must  be  persons  experienced  in  banking  or  finance. 
Not  more  than  one  shall  be  appointed  from  any  federal  reserve 
district,  and  due  regard  is  to  be  given  to  the  different  com- 
mercial, industrial,  and  geographical  divisions  of  the  country. 
The  term  of  office  of  the  appointed  members  is  ten  years ;  but 
those  first  selected  are  to  serve  one  for  two,  one  for  four 
years,  and  so  on,  so  that  the  term  of  office  of  one  member  may 
expire  every  two  years. 

Under  this  arrangement  a  majority  of  the  board,  in  the 
absence  of  death  and  resignation,  will  never  be  reconstituted 
at  any  one  time.  Each  President  will  select  two  of  the  ap- 
pointed members :  one  in  the  second  year  of  his  term  of  office, 
and  one  in  the  fourth.  The  Secretary  of  the  Treasury  will, 
of  course,  be  a  new  member  appointed  at  the  beginning  of 
each  presidential  term.  The  term  of  office  of  the  Comptroller 
of  the  Currency  is  for  five  years,  so  that  here  a  variable  ele- 
ment is  introduced.  It  may  happen  that  some  Presidents  will 


734         THE  FEDERAL  RESERVE  SYSTEM 

never  appoint  more  than  three  members  during  their  term  of 
office.  Generally,  however,  each  President  will  appoint  four 
members;  but  the  last  appointment,  giving  a  majority  on  the 
board,  will  not  be  made  until  his  final  year  of  office.  Lack 
of  continuity  and  the  possibility  of  a  political  board  were 
much  greater  under  the  provisions  for  selecting  the  Federal 
Reserve  Board  which  were  in  the  measure  at  various  stages 
while  it  was  passing  through  Congress.  The  arrangements 
finally  adopted  would  seem  to  make  it  reasonably  certain  that 
the  Federal  Reserve  Board  will  be  free  from  both  these  de- 
fects. 

Organization  of  the  system  will  be  complete l  with  the 
selection  of  the  members  of  the  Federal  Advisory  Council. 
This  Council  is  to  consist  of  as  many  members  as  there  are 
Federal  Reserve  districts,  the  board  of  directors  of  each  Fed- 
eral Reserve  Bank  selecting  one  member.  The  function  and 
powers  of  the  council  are  purely  consultative.  It  is  to  meet 
regularly  four  times  each  year  at  Washington,  and  at  other 
times  there  or  elsewhere  if  deemed  necessary  by  the  Council 
itself.  It  is  authorized  to  confer  directly  with  the  Federal  Re- 
serve Board,  to  call  for  information,  and  make  oral  or  written 
representations  concerning  matters  within  the  jurisdiction  of 
the  Federal  Reserve  Board.  It  may  prove  to  be  an  important 
part  of  the  organization,  but  this  does  not  seem  probable. 
With  a  scattered  membership  and  holding  regular  meetings 
only  at  long  intervals,  it  is  not  to  be  expected  that  the  Council 
will  be  in  close  touch  with  the  Federal  Reserve  Board,  or  in  a 
position  to  formulate  policies  and  urge  them  effectively. 
From  individual  members  of  the  Council,  the  Federal  Reserve 
Board  should  secure  valuable  information  regarding  conditions 
in  different  parts  of  the  country ;  but  the  work  of  the  council 
itself  as  an  organized  body  seems  likely  to  be  of  a  formal  and 
perfunctory  nature.  The  importance  of  the  Council  would 
doubtless  have  been  measurably  increased  if  the  proposal  had 

1  After  the  Reserve  Banks  have  been  in  operation  long  enough  to  be 
running  smoothly,  not  a  few  branches  will  doubtless  be  organized. 
Branches  are  to  have  boards  of  directors,  three  of  the  members  of  which 
are  to  be  chosen  by  the  Federal  Reserve  Board,  and  four  by  the  directors 
of  the  parent  Reserve  Bank.  Branches  are  to  be  operated  under  rules  and 
regulations  approved  by  the  Federal  Reserve  Board. 


THE  FEDERAL  RESERVE  ACT          735 

been  adopted  that  its  chairman  should  sit,  even  though  with- 
out a  vote,  on  the  Federal  Reserve- Board. 

CAPITAL,    EARNINGS,    DEPOSITS    OF   THE    FEDERAL    RESERVE 

BANKS 

Since  the  capital  stock  of  each  of  the  Federal  Reserve  Banks 
is  to  be  exactly  6  per  cent,  of  the  capital  and  surplus  of  the 
member  banks  in  its  district,  it  will  always  be  subject  to  slight 
variations.  If  all  national  banks  enter  the  system  at  the  out- 
set, the  total  subscribed  capital  of  the  Federal  Reserve  Banks 
will  be  a  little  more  than  one  hundred  million  dollars.  Sub- 
scriptions may  perhaps  fall  somewhat  below  this  amount,  since 
with  the  exception  of  the  reserve  agent  banks,  no  penalty  at- 
taches to  failure  to  subscribe  until  twelve  months  after  the 
passage  of  the  act.  Few  state  banking  institutions  will  enter 
the  system  at  the  beginning.  In  many  states  legislation  is 
necessary  to  permit  them  to  invest  in  the  stock  of  the  Federal 
Reserve  Banks,  and  to  enable  them  to  count  balances  with  the 
Federal  Reserve  Banks  as  a  part  of  their  required  reserves. 
It  is  to  be  presumed  also,  that  such  institutions,  since  they 
can  enter  at  any  time,  will  wait  to  see  whether  the  system 
is  working  to  the  satisfaction  of  neighboring  national 
banks.1 

There  will  always  be  wide  differences  between  the  capital 
and  other  resources  of  the  various  Federal  Reserve  Banks. 
Neither  the  capital  nor  the  resources  of  existing  banks  can  be 
made  the  basis  for  dividing  the  country  into  Federal  Reserve 
districts.  Geographical  consideration  will  necessarily  require 
the  creation  of  a  number  of  districts  in  sparsely  settled  parts 
of  the  country,  in  which  banking  resources  are  comparatively 
small.  No  Federal  Reserve  Bank  may,  however,  be  established 
until  it  has  a  subscribed  capital  stock  of  at  least  four  million 
dollars.  It  would,  therefore,  seem  to  follow  that  the  organiza- 
tion committee  is  precluded  from  forming  any  district  in  which 

1  State  banks  and  trust  companies  are  elegible  for  membership,  if  they 
have  a  sufficient  capital  to  entitle  them  to  become  national  banks  in  the 
places  where  they  are  situated.  On  becoming  member  banks,  they  must 
comply  with  the  provisions  of  the  national  banking  law  regarding  reserves, 
examinations  (the  state  examinations  may  be  accepted),  and  various  other 
general  provisions  of  the  national  banking  law. 


736        THE  FEDERAL  RESERVE  SYSTEM 

6  per  cent,  of  the  capital  and  surplus  of  the  national  and  state 
banks  is  less  than  this  minimum  amount.  There  are  indeed 
provisions  in  the  act  designed  to  meet  the  contingency  of  fail- 
ure by  banks  to  subscribe  in  sufficient  numbers  to  provide  a 
minimum  capital;  but  they  would  not  seem  to  authorize  the 
organization  committee  to  create  districts  in  which  resort  to 
these  provisions  would  be  inevitable.1 

Whether  the  capital  of  the  Federal  Reserve  Banks  is  large 
or  small  is  a  matter  of  no  great  importance.  Subscriptions 
to  capital  provide  a  comparatively  small  part  of  the  resources 
of  banks.  The  capital  is  an  indication  that  those  conducting  a 
bank  have  something  at  stake,  and  is  also  a  margin  of  safety 
against  loss  to  depositors.  These  Federal  Reserve  Banks  are, 
however,  to  accept  deposits  from  banks  only,  and  are  ordinarily 
to  confine  their  dealings  to  the  banks.  In  these -circumstances, 
there  is  practically  no  difference  between  the  funds  which  the 
federal  reserve  banks  will  secure  from  member  banks  in  pay- 
ment of  subscriptions  to  capital  stock,  and  the  funds  which 
will  be  deposited  with  them  by  member  banks.  The  depositors 
are  the  stockholders  and,  therefore,  there  is  no  separate  in- 
terest to  be  protected  by  a  margin  of  safety. 

Shareholders  in  the  reserve  banks  are  entitled  to  a  cumu- 
lative dividend  of  6  per  cent.  A  limited  dividend  is  obviously 
wise,  since  it  tends  to  eliminate  the  profit-making  motive  in 
the  management.  Whether  all  the  Federal  Reserve  Banks  will 
regularly  earn  the  6  per  cent,  dividend  is,  of  course,  not  cer- 
tain; but  it  seems  highly  probable,  since  the  danger  of  serious 
losses  is  remote,  and  interest  will  presumably  not  be  paid  to 
the  member  banks  on  their  balances.  All  earnings  in  excess 
of  the  dividend  are  to  be  paid  to  the  Government  of  the  United 
States  as  a  franchise  tax;  but  half  of  these  surplus  earnings 
are  to  be  paid  into  a  surplus  fund  until  it  has  become  40  per 
cent,  of  the  capital  stock.  Whatever  is  received  by  the  Gov- 
ernment from  the  Federal  Reserve  Banks  is  to  be  used  at  the 
discretion  of  the  Secretary  of  the  Treasury,  either  to  increase 

1  In  case  subscriptions  by  the  banks  of  a  district  are  inadequate,  stock 
is  to  be  offered  to  the  general  public;  and  if  the  response  of  the  public 
is  inadequate,  the  stock  is  to  be  taken  by  the  Government  of  the  United 
States.  Neither  privately  owned  nor  government  stock  is  entitled  to  voting 
power.  [In  no  district  were  subscriptions  by  the  banks  "  inadequate."] 


THE  FEDERAL  RESERVE  ACT          737 

the  gold  reserve  against  United  States  notes  or  for  the  reduc- 
tion of  the  interest-bearing  debt. 

The  federal  reserve  banks  will  doubtless  secure  very  large 
resources  through  the  deposit  with  them  of  the  moneys  held  in 
the  general  fund  of  the  Treasury  of  the  United  States,  al- 
though no  power  over  the  disposition  which  shall  be  made  of 
these  funds  is  granted  either  to  the  Federal  Reserve  Banks  or 
to  the  Federal  Reserve  Board.  Entire  discretion  remains  with 
the  Secretary  of  the  Treasury.  He  may  continue  the  inde- 
pendent treasury  system  without  change ;  he  may  continue  to 
deposit  funds  with  member  banks,  just  as  hitherto  he  has 
placed  deposits  with  national,  banks;  and  finally  he  may 
deposit  with  any  or  all  of  the  Federal  Reserve  Banks,  using 
them  as  government  fiscal  agencies.  The  responsibility  of 
the  Secretary  of  the  Treasury  is  in  no  way  changed.  Almost 
certainly  in  practice,  however,  the  bulk  of  the  free  funds  of  the 
Government  will  be  placed  with  the  Federal  Reserve  Banks, 
and  doubtless  the  opinion  of  the  Federal  Reserve  Board  will 
determine  the  distribution  of  these,  funds  between  the  various 
banks. 

The  lion's  share  of  the  cash  resources  of  the  Federal  Reserve 
Banks  will  come  from  the  reserves  and  working  balances  de- 
posited with  them  by  member  banks.  Under  the  terms  of  the 
act,  part  of  the  required  reserves  of  member  banks  must  be 
placed  with  Federal  Reserve  Banks.  This  is  a  novelty  in  cen- 
tral banking  legislation,  but  is  based  upon  sound  principle,  and 
is  especially  to  be  commended  for  this  country  where,  on  ac- 
count of  the  absence  of  branch  banking,  the  number  of  banks  to 
be  served  by  the  regional  banks  will  be  very  great.  It  makes 
certain  some  increase  in  the  resources  of  the  Federal  Reserve 
Banks,  along  with  the  expansion  of  the  credit  liabilities  of  the 
member  banks.  It  also  lessens  somewhat  the  danger  of  un- 
necessary withdrawals  of  funds  from  the  reserve  banks  in 
emergencies. 

Reserve  requirements  of  the  national  banking  law  are  rad- 
ically changed.  In  addition  to  the  requirement  that  a  part 
of  the  reserve  of  the  banks  be  kept  with  the  Federal  Reserve 
Banks,  the  reserve  ratio  is  reduced  for  all  classes  of  banks; 
the  practice  of  keeping  a  part  of  the  reserve  of  country  and 


738        THE  FEDERAL  RESERVE  SYSTEM 

reserve  city  banks  with  reserve  agents  is  to  be  discontinued; 
and  a  distinction  for  reserve  purposes  is  made  between  time  and 
demand  deposits.  Some  of  these  changes  become  effective 
as  soon  as  the  new  system  is  established;  others  are  to  be 
made  in  a  succession  of  steps  and  completed  three  years  after 
the  passage  of  the  act. 

Time  deposits  are  to  comprise  deposits  payable  after  thirty 
days,  and  are  to  include  certificates  of  deposit  and  savings 
accounts  subject  to  thirty  days'  notice.  A  reserve  of  5  per 
cent,  is  required  against  these  deposits,  and  no  distinction  is 
made  between  country  and  city  banks.  This  low  reserve  re- 
quirement will  certainly  lead  the  banks  to  encourage  the  con- 
version of  demand  obligations  into  time  obligations.  A  rela- 
tively large  part  of  the  deposits  of  banks  in  most  European 
countries  is  payable  at  notice.  It  is  obviously  an  arrange- 
ment which  shields  the  banks  somewhat  from  the  effects  of 
sudden  waves  of  distrust. 

Against  demand  deposits  the  ratio  of  reserves  is  also  to 
be  reduced  at  once ;  but  the-  existing  classification  of  banks  is 
to  be  retained.  The  required  ratio  for  country  banks  is  re- 
duced from  15  to  12  per  cent.,  for  reserve  city  banks,  from  25 
to  15  per  cent.,  and  for  central  reserve  city  banks  from  25  to 
1 8  per  cent.  A  provision  in  the  bill  excluding  from  reserves 
the  5  per  cent,  fund  held  in  Washington  against  outstanding 
circulation  is  a  slight  offset  to  this  reduction  in  reserve  ratios. 

As  regards  the  banks  in  central  reserve  cities,  the  initial 
arrangement  regarding  the  disposition  to  be  made  of  their 
reserve  is  also  the  final  arrangement.  They  must  hold  %s  of 
their  reserve  in  vault,  %s  in  their  Federal  Reserve  Bank,  and 
the  remaining  5As  either  in  vault  or  with  their  federal  reserve 
bank.  Other  banks  are  allowed  a  period  of  transition.  Re- 
serve city  banks  for  three  years  must  hold  %s  of  their  reserve 
in  vault,  thereafter  5/i5',  for  twelve  months  they  must  keep 
with  their  Federal  Reserve  Bank  %5,  adding  an  additional 
Ms  every  six  months;  so  that  at  the  end  of  two  years  they 
will  have  a  deposit  of  6/i*>.  During  the  three  year  period  the 
remainder  of  the  reserve  may  be  deposited  with  reserve  agent 
banks  in  a  central  reserve  city,  or  by  what  would  seem  to  be 
an  inadvertent  extension  of  existing  practice  with  those  in 


THE  FEDERAL  RESERVE  ACT          739 

reserve  cities ;  but  thereafter  it  must  be  either  in  vault  or  with 
a  Federal  Reserve  Bank.  Country  banks  must  hold  in  vault 
5A2  of  their  reserve  for  three  years,  thereafter  %2j  for  twelve 
months  must  deposit  with  their  Federal  Reserve  Bank  %2,  and 
an  additional  ^  every  six  months  until  %2  are  deposited  at 
the  end  of  two  years.  The  remainder  of  the  reserve  may  be 
kept  for  three  years  with  reserve  agent  banks,  but  at  the  end 
of  that  period  must  be  either  in  vault  or  in  a  Federal  Reserve 
Bank. 

Whether  these  changes  in  reserves,  together  with  payments 
by  the  banks  of  subscriptions  to  the  capital  stock  of  the  reserve 
banks,  will  make  necessary  any  considerable  amount  of  loan 
contraction,  cannot  be  precisely  determined.  If  numbers  of 
state  banking  institutions  enter  the  system  at  the  beginning, 
some  strain  may  be  occasioned,  since,  although  these  require- 
ments are  less  than  those  to  which  the  national  banks  have 
been  subject,  they  exceed  those  imposed  upon  banks  by  the  law 
of  many  of  the  states.  In  order  to  enable  the  banks  to  avoid 
contraction,  the  act  contains  a  provision  under  which  one-half 
of  each  instalment  of  reserve  to  be  placed  in  reserve  banks  may 
be  received  in  the  form  of  the  kinds  of  commercial  bills  of 
exchange  which  the  reserve  banks  may  purchase  in  the  open 
market.  It  is,  however,  most  unlikely  that  the  banks  will  be 
able  to  make  much  use  of  this  arrangement,  because  of  the 
scanty  amount  of  such  paper  available. 

FEDERAL   RESERVE   NOTES   AND  NATIONAL   BANK   NOTES 

The  power  to  issue  notes  is  a  useful  but  not  indispensable 
resource  for  institutions  having  the  responsibilities  which  are 
placed  upon  the  Federal  Reserve  Banks.  The  issue  of  notes 
by  a  central  bank  enables  it  to  supply  domestic  requirements 
for  currency  without  reducing  its  holdings  of  reserve  money. 
In  the  absence  of  the  right  of  issue,  it  would  only  be  necessary 
to  accumulate  in  ordinary  times  a  somewhat  greater  amount  of 
reserve  money,  to  provide  for  seasonal  and  emergency  needs. 
General  public  confidence  in  the  Federal  Reserve  Banks  would, 
however,  be  far  less  secure  if  they  were  not  empowered  to 
issue  notes.  This  is  because  of  the  exaggerated  importance 
almost  universally  attached  to  the  right  of  note  issue,  even  in 


740        THE  FEDERAL  RESERVE  SYSTEM 

countries  in  which  the  check  has  become  a  universal  medium 
of  payment. 

The  particular  provisions  in  the  act  regarding  the  issue  of 
notes  are  extremely  complicated,  and  are  in  some  respects 
quite  without  precedent.  The  notes  for  which  provision  was 
made  in  the  bill  of  the  Monetary  Commission  were  to  be  bank 
notes  pure  and  simple,  subject  to  a  variety  of  restrictions  de- 
signed to  keep  the  total  amount  issued  within  safe  limits.  The 
notes  which  are  to  be  issued  'under  the  provisions  of  the  act 
are  certainly  quite  as  well  safeguarded  in  this  respect.  In 
addition,  the  notes  are  made  obligations  of  the  Government 
of  the  United  States,  which  also  undertakes  to  redeem  them 
at  Washington.  The  obligation  of  the  Government  is  in 
addition  to  and  does  not  take  the  place  of  any  banking  safe- 
guard. It  is  designed  to  meet  the  desires  of -the  very  large 
number  of  people  throughout  the  country  who  believe  that  the 
issue  of  money  is  a  government  function.  To  many  bankers 
and  others  familiar  with  our  past  financial  history,  this  pro- 
vision in  the  bill  was  most  distasteful.  Their  opposition, 
though  natural,  was,  however,  neither  very  practical  nor  rea- 
sonable. It  was  based  very  largely  upon  the  fear  that  the 
government  obligation  on  the  notes  would  prove  an  entering 
wedge  for  an  issue  of  fiat  money  at  some  future  time.  But 
paper  money  cannot  be  issued  under  the  terms  of  the  act  for 
the  purpose  of  meeting  government  expenditures.  Additional 
legislation  would  be  necessary,  and  the  possibility  of  such  legis- 
lation is  not  appreciably  increased  by  making  the  notes  which 
are  to  be  issued  by  the  reserve  banks  an  obligation  of  the 
Government.  On  the  other  hand,  this  provision  won  many 
friends  for  this  important  piece  of  banking  legislation ;  it 
allayed  opposition  which  would  always  have  been  a  serious 
menace  to  the  permanence  of  the  new  system. 

The  quantity  of  the  new  notes  which  may  be  issued  is  wholly 
within  the  control  of  the  Federal  Reserve  Board ;  but  the 
initiative  in  taking  out  circulation  rests  entirely  with  the  boards 
of  directors  of  the  reserve  banks.  Applications  for  notes  may 
be  made  at  any  time  by  a  reserve  bank  to  its  district  reserve 
agent,  the  member  of  its  board  of  directors  who  is  the  medium 
of  communication  between  the  bank  and  the  Board.  Redis- 


THE  FEDERAL  RESERVE  ACT          741 

counted  commercial  loans  equal  in  amount  to  the  notes  applied 
for  must  be  deposited  with  the  agent,  and  a  reserve  in  gold 
of  40  per  cent,  must  be  maintained.  (A  reserve  of  35  per 
cent,  in  gold  or  lawful  money  is  required  against  deposits.) 
The  Board  may  grant  in  whole  or  in  part,  or  reject  entirely, 
applications  for  notes,  and  may  also  impose  such  interest 
charge  upon  the  notes  as  it  may  deem  advisable.  The  notes 
are  to  be  a  prior  lien  on  the  assets  of  the  issuing  banks,  and 
there  is,  therefore,  no  possibility  of  loss  to  note  holders,  nor 
any  to  the  Government  on  account  of  the  obligation  which  it 
assumes. 

Such  part  of  the  40  per  cent,  gold  reserve  against  the  notes 
as  may  be  deemed  advisable  by  the  Secretary  of  the  Treasury, 
but  in  no  case  less  than  5  per  cent.,  must  be  deposited  in  the 
Treasury  of  the  United  States  for  the  redemption  of  the  notes 
in  Washington.  Each  Reserve  Bank  is  required  to  redeem  not 
only  its  own  notes  but  also  those  of  the  other  Reserve  Banks 
either  in  gold  or  in  lawful  money;  redemption  in  Washington 
is  in  gold  alone.  In  practice  it  is  certain  that  Reserve  Banks 
will  redeem  the  notes  in  gold  over  the  counter ;  and  it  is  also 
certain  that  slight  use. will  be  made  of  the  redemption  ma- 
chinery at  Washington.  Member  banks  will  certainly  deposit 
the  notes  with  their  own  reserve  banks,  which  are  required 
to  accept  the  notes  of  other  banks  at  par.  The  reserve  banks, 
in  turn,  are  required  under  the  law  to  return  for  redemption 
the  notes  issued  by  other  reserve  banks.  Redemption  at 
Washington  has  apparently  been  provided  because  national 
bank  notes  are  redeemed  there  in  large  volume  every  year;  a 
result  of  the  circumstance  that  the  present  number  of  issuing 
banks  is  so  large  as  to  make  counter  redemption  much  more 
costly. 

Various  provisions  in  the  act  are  evidently  designed  to  keep 
the  issue  of  notes  within  safe  limits;  but  not  much  reliance 
should  be  placed  upon  them.  Reserve  Banks  may  not,  under 
penalty  of  a  prohibitive  tax  of  10  per  cent.,  pay  out  the  notes 
of  other  Reserve  Banks.  If  these  banks,  like  the  Scotch  banks, 
were  working  in  the  same  territory,  regular  redemption  would 
check  over-issue  on  the  part  of  any  one  of  them.  But  under 
a  system  of  regional  banks,  each  with  its  own  territory,  there 


742  THE  FEDERAL  RESERVE  SYSTEM 

will  be  only  a  very  irregular  relation  between  the  amount  of 
notes  put  out  by  any  one  and  the  amount  which  will  be  re- 
ceived by  the  others.  Moreover,  it  should  be  borne  in  mind 
that  regular  redemption  is  no  check  whatever  upon  general 
expansion,  either  in  the  form  of  notes  or  of  deposits,  when 
all  banks  are  expanding  credit  at  the  same  time. 

Not  much  effect  also  in  checking  over-issue  is  to  be  looked 
for  from  those  provisions  in  the  act  which  require  a  40  per 
cent,  reserve  in  gold  and  impose  a  graduated  tax  upon  reserve 
deficiencies.  A  considerable  part  of  the  total  reserves  of  the 
Reserve  Banks  is  certain  to  be  in  gold ;  and  deposit  liabilities 
are  certain  to  be  vastly  greater  than  those  for  notes  in  cir- 
culation. The  circumstances  are  hardly  conceivable  in  which 
a  Reserve  Bank  would  not  have  an  amount  of  gold  in  its  entire 
reserve  ample  to  provide  a  gold  reserve  for  such  notes  as  it 
might  issue.  The  special  tax  on  note  reserve  deficiency  can 
therefore  be  readily  evaded  by  shifting  the  deficiency  to  the 
reserve  against  deposits.  Deficient  reserves  are  only  allowed 
when  reserve  requirements  are  suspended  by  the  Federal  Re- 
serve Board.  The  Board  is  to  impose  a  graduated  tax  on  all 
deficiencies  except  in  the  note  reserve.  On  note  reserve  de- 
ficiencies, the  tax  imposed  in  the  law  is  to  be  added  to  the 
rate  of  discount  of  the  reserve  banks.  The  arrangement 
would  seem  to  be  a  most  unworkable  one,  since  there  is  no 
means  of  knowing  to  what  extent  a  borrowing  bank  will  have 
occasion  to  use  the  proceeds  of  its  loan  in  the  form  of  notes. 
Fortunately  this  provision  of  the  act  is  never  likely  to  become 
operative. 

After  all,  for  proper  use  of  the  right  of  issue  under  the  act 
the  main  reliance  must  and  should  be  on  wise  and  experienced 
management  for  the  reserve  banks,  and  above  all  on  a  con- 
servative Federal  Reserve  Board.  Restrictions  which  would 
make  over-issue  impossible  would  also  deprive  the  right  of 
issue  of  all  usefulness  as  a  means  of  extending  credit.  More- 
over, the  danger  of  the  over-expansion  of  credit  in  the  form 
of  deposits  is  vastly  greater  than  it  is  in  the  form  of  bank 
notes  in  any  country  in  which  deposit  credits  have  become  the 
more  important  credit  medium. 

One  of  the  most  perplexing  questions  that  presented  itself 


THE  FEDERAL  RESERVE  ACT  743 

in  framing  the  act  was  the  disposition  to  be  made  of  the  na- 
tional bank  notes  and  the  2  per  cent,  government  bonds  which 
secure  very  nearly  all  of  them.  When  the  measure  reached 
the  Senate,  it  contained  provisions  which  contemplated  the 
gradual  substitution  of  Federal  Reserve  notes  for  the  national 
bank  notes.  But  when  it  was  pointed  out  that  this  would 
require  the  Reserve  Banks  regularly  to  rediscount  at  least  seven 
hundred  million  dollars  of  commercial  paper,  in  order  to  sup- 
port the  existing  volume  of  currency,  it  was  felt  that  some 
other  arrangement  must  be  made.  A  plan  to  unify  all  the 
varieties  of  paper  money  now  in  circulation,  with  the  excep- 
tion of  the  silver  certificate,  by  the  issue  of  an  equal  amount 
of  United  States  notes,  backed  by  an  ample  gold  reserve, 
found  influential  support ;  but  it  was  wisely  decided  to  present 
this  in  a  separate  measure.  The  particular  provisions  regard- 
ing the  national  bank  notes  and  the  bonds  contained  in  the  act 
•should  be  regarded,  therefore,  as  a  temporary  arrangement 
pending  future  legislation. 

In  order  to  avoid  the  contraction  of  the  currency  which 
would  follow  the  refusal  of  many  national  banks  to  enter 
the  system,  each  Reserve  Bank  is  authorized  to  purchase  bonds 
and  take  out  circulation  similar  in  all  respects  to  the  notes 
issued  by  the  national  banks.  After  the  end  of  a  period  of 
two  years,  additional  bonds  may  be  purchased,  but  only  from 
member  banks,  and  at  the  discretion  of  the  Federal  Reserve 
Board.  Member  banks  desiring  to  retire  circulation  and  dis- 
pose of  their  bonds,  may  make  application  to  the  Board,  which 
may  require  the  Reserve  Banks  to  purchase  them.  No  more 
than  twenty-five  million  dollars  of  bonds  may  be  purchased 
in  any  one  year,  and  the  amount  purchased  is  to  be  distributed 
among  the  various  Reserve  Banks  in  proportion  to  their  capital 
stock.  Bonds  thus  purchased  may  be  used  as  a  basis  for  ad- 
ditional national  bank  notes  by  the  reserve  banks,  or  they  may 
be  converted  into  3  per  cent,  government  obligations  —  one- 
half  into  thirty-year  3  per  cent,  bonds,  and  one-half  into  one- 
year  3  per  cent,  notes,  both  issues  without  the  circulation 
privilege.  In  taking  the  one-year  notes,  a  Reserve  Bank  enters 
into  an  obligation  to  purchase  an  equal  amount  at  each  suc- 
cessive maturity  for  thirty  years.  The  purpose  of  the  notes 


744  THE  FEDERAL  RESERVE  SYSTEM 

is  to  provide  the  Reserve  Banks  with  a  readily  marketable  asset, 
the  sale  of  which  abroad  may  prove  serviceable  in  periods  of 
strain,  and  the  domestic  sale  of  which  will  enable  the  Reserve 
Banks  to  make  their  discount  rates  effective  in  the  money 
market.  Government  short-term  obligations  are  used  for 
these  purposes  by  many  of  the  European  central  banks. 

The  existing  volume  of  national  bank  notes  will  not  be  re- 
duced under  the  terms  of  the  act,  except  in  so  far  as  the  Re- 
serve Banks  convert  2  per  cent,  bonds  into  3  per  cent,  bonds 
or  notes.  There  may  even  be  some  slight  increase  in  the  total 
of  national  bank  notes  in  circulation,  since  banks  may  use  for 
this  purpose  the  small  quantity  of  bonds  not  already  absorbed 
in  this  way.  Little  concern,  however,  need  be  felt  because  the 
national  bank  notes  are  not  to  be  retired.  Present  require- 
ments for  money  to  be  used  outside  the  banks  are  sufficient 
to  absorb  all  the  notes  at  present ;  and  with  the  growth  in  popu- 
lation a  somewhat  greater  quantity  could  be  absorbed  in  future. 

LENDING   OPERATIONS    OF    THE    FEDERAL    RESERVE    BANKS 

The  normal  lending  operations  of  the  Federal  Reserve 
banks  are  limited  to  the  rediscounting  for  member  banks  of 
commercial  loans  maturing  within  ninety  days.  Commercial 
loans  are  generally  defined  in  the  act  as  "  notes,  drafts,  and 
bills  of  exchange  arising  out  of  actual  commercial  transactions ; 
that  is,  notes,  drafts,  and  bills  of  exchange  issued  or  drawn 
for  agricultural,  industrial,  or  commercial  purposes,  or  the 
proceeds  of  which  have  been  used  or  are  to  be  used  for  such 
purposes."  The  Federal  Reserve  Board  is  authorized  to  de- 
fine more  precisely  the  nature  and  character  of  eligible  paper. 
To  make  assurance  doubly  sure,  the  rediscount  of  loans  secured 
by  stocks  and  bonds  is  specifically  prohibited.  The  act  also 
provides  that  six  months'  maturities  of  paper  drawn  and  used 
for  agricultural  purposes  or  based  on  live  stock  may  be  redis- 
counted. 

In  confining  rediscounts  to  commercial  loans,  the  act  is  more 
stringent  than  that  governing  the  operations  of  central  banks 
in  Europe.  In  practice,  however,  the  bulk  of  the  loans  of 
these  institutions  are  in  connection  with  commercial  transac- 
tions. While  this  restriction  may  in  some  particular  emer- 


THE  FEDERAL  RESERVE  ACT          745 

gency  hamper  the  Reserve  Banks  in  giving  assistance  to  some 
threatened  bank,  it  is  upon  the  whole  amply  justifiable.  Under 
our  banking  system  in  the  past  the  collateral  loan  has  enjoyed 
a  prestige  which  it  is  hoped  will  be  transferred  to  commercial 
loans.  Exclusion  of  collateral  loans  from  rediscount  will  cer- 
tainly contribute  much  to  bring  this  about.  The  restriction 
also  gives  the  public  greater  confidence  that  the  resources  of 
the  Reserve  Banks  will  be  generally  available  throughout  the 
entire  country. 

One  of  the  reasons  which  has  been  advanced  for  confining 
rediscounts  to  commercial  loans  is  based  upon  certain  miscon- 
ceptions of  the  true  nature  of  commercial  paper  —  miscon- 
ceptions which,  if  adopted  by  the  management  of  the  Reserve 
Banks  in  formulating  their  policy,  may  have  disastrous  con- 
sequences. It  has  been  contended  on  all  sides  during  the  last 
few  years  that  commercial  paper  was  from  its  very  nature 
liquid ;  and  further,  that  credit  could  therefore  safely  be  granted 
to  an  extent  limited  only  by  the  amount  of  such  paper.  Both 
of  these  contentions  are  hopelessly  fallacious.  In  an  emer- 
gency, no  kind  of  loan  is  liquid  to  any  considerable  extent. 
Business  cannot  suddenly  be  deprived  of  the  amount  of  credit 
to  which  it  has  become  adjusted.  It  is,  indeed,  often  said  that 
loans  based  upon  any  commodity  entering  into  general  con- 
sumption can  be  quickly  liquidated.  This  can  be  done  as  re- 
gards any  particular  loan ;  but  supplies  for  the  immediate  and 
distant  future  must  be  in  process  of  production  and  they  will 
require  a  new  batch  of  loans.  The  view  that  credit  can  be 
safely  granted  to  the  full  extent  of  merchandise  in  process  of 
distribution  and  even  in  process  of  manufacture  is  equally 
fallacious.  Credit  affects  price.  Liberal  discounts  may  cause 
speculative  advances  in  commodity  prices,  stimulating  exces- 
sive prices  by  wholesalers,  jobbers,  and  retailers,  as  well  as 
by  speculative  holders  pure  and  simple.  There  is  no  mechan- 
ical or  statistical  test  for  the  amount  of  credit  which  may  be 
safely  granted,  whether  the  loans  be  commercial  or  collateral. 
Over-expansion  is  possible  by  both  operations. 

Commercial  loans  will  become  the  most  liquid  asset  that 
member  banks  can  hold,  simply  because  they  can  be  redis- 
counted  with  the  Reserve  Banks.  A  smaller  amount  of  Bank 


746         THE  FEDERAL  RESERVE  SYSTEM 

funds  will  be  employed  in  the  call  loan  market.  But  what- 
ever amount  remains  available  for  that  use  will  be  subject  to 
far  less  seasonal  fluctuation  both  in  volume  and  in  rates.  The 
retention  of  fixed  reserve  ratios,  even  though  they  may  be 
suspended  by  the  Federal  Reserve  Board,  will  probably  lead 
many  city  banks  to  use  the  call  loan  market  to  a  moderate  ex- 
tent, since  it  will  enable  them  to  avoid  the  necessity  of  resort- 
ing to  the  reserve  banks  for  rediscounts  whenever  reserves 
momentarily  drop  below  legal  requirements.  A  somewhat 
larger  proportion  of  time  loans  will  doubtless  be  used  in  con- 
nection with  stock  exchange  dealings ;  but  the  available  supply 
of  call  money  will  presumably  be  sufficient  to  permit  the  con- 
tinuance of  the  present  American  practice  of  daily  delivery  of 
securities. 

At  the  outset,  on  account  of  the  widespread  prejudice  among 
bankers  against  rediscounting,  the  demand  for  accommodation 
from  the  Reserve  Banks  may  not  be  large ;  but  this  prejudice 
will  surely  die  away  in  time,  and  most  if  not  all  of  the  Reserve 
Banks  will  suffer  from  no  lack  of  regular  business,  except 
in  periods  of  business  depression.  Member  banks  in  those 
parts  of  the  country  in  which  the  supply  of  credit  is  inadequate 
for  local  requirements  will  lend  more  closely,  while  banks 
which  regularly  have  more  funds  than  can  be  thus  employed 
will  purchase  more  commercial  paper  from  note  brokers  and 
perhaps  rediscount  for  banks  in  those  parts  of  the  country  in 
which  rates  are  normally  high. 

Aside  from  the  government  account,  member  banks  are  to 
provide  the  funds  for  the  reserve  banking  system.  Competi- 
tion with  member  banks  would  therefore  and  justly  occasion 
serious  dissatisfaction.  Managed  by  boards  of  directors  a 
majority  of  the  membership  of  which  is  to  be  selected  by  the 
member  banks,  there  would  seem  to  be  little  danger  of  serious 
competition  from  the  Reserve  Banks.  Nevertheless  the  act 
places  such  restrictions  upon  dealings  by  the  Reserve  Banks 
with  the  general  public  that  little  or  no  competition  will  be 
possible. 

The  Reserve  Banks  are  permitted  to  engage  in  three  kinds  of 
open  market  operations :  ( I )  dealings  in  government  securi- 
ties, and  also  in  obligations  of  the  states  and  local  bodies, 


THE  FEDERAL  RESERVE  ACT          747 

maturing  within  six  months  and  issued  in  anticipation  of  taxes  ; 
(2)  dealings  in  foreign  exchange;  and  (3)  dealings  in  domes- 
tic bills  of  exchange. 

The  purchase  and  sale  of  government  bonds  and  notes  and 
state  and  local  short-term  obligations  require  no  detailed  con- 
sideration. In  periods  of  inactive  demand  for  rediscounts, 
investments  of  this  kind  will  doubtless  be  made  by  the  Reserve 
Banks  in  order  to  employ  surplus  funds. 

The  right  to  engage  in  foreign  exchange  dealings  will  also 
be  similarly  useful,  surplus  funds  being  invested  in  foreign 
bills.  Moreover,  if  any  of  the  Reserve  Banks  find  that  their 
resources  are  regularly  in  excess  of  domestic  requirements, 
they  may  be  used  to  facilitate  the  financing  of  the  foreign 
trade  of  the  country  with  domestic  capital.  It  is  also  very 
generally  believed  that  the  power  to  engage  in  foreign  ex- 
change operations  may  be  so  used  that  it  will  be  possible  to 
rely  upon  securing  abundant  foreign  funds  in  periods  of  finan- 
cial strain.  This  is  most  unlikely.  It  is  entirely  possible  for 
a  small  country  to  rely  upon  holdings  of  foreign  bills  as  a 
means  of  influencing  the  foreign  exchanges,  and  even  for  such 
supplies  of  gold  as  may  be  needed  on  occasions  when  confi- 
dence is  threatened.  But  the  banks  of  a  large  country  must 
rely  mainly  upon  domestic  resources,  since  the  amount  of  cash 
and  credit  needed  in  an  emergency  is  too  great  to  be  secured 
from  foreign  money  markets.  It  should  be  the  policy  of  the 
Reserve  Banks  to  maintain  themselves  in  a  condition  of  such 
abundant  strength  as  to  be  wholly  independent  of  foreign  as- 
sistance. Moreover,  if  they  maintain  strong  reserves  in  ordi- 
nary times,  they  will  not  be  disturbed  on  account  of  gold  ex- 
ports. Gold  exports  amounting  to  fifty,  or  even  a  hundred 
million  dollars  should  not  be  made  the  occasion  for  obstruc- 
tive measures  such  as  are  adopted  by  many  of  the  European 
central  banks.  Measures  of  this  kind  are  generally  an  indi- 
cation that  the  credit  structure  rests  upon  an  inadequate  foun- 
dation. New  York  has  been  a  free  gold  market  in  the  past, 
and  even  under  our  imperfect  banking  system,  there  has  always 
been  a  sufficient  amount  of  gold  for  every  banking  purpose. 
Moreover,  restrictions  placed  upon  gold  movements  can  have 
but  temporary  effects;  in  the  long  run  the  distribution  of  gold 


748         THE  FEDERAL  RESERVE  SYSTEM 

among  the  various  commercial  countries  is  determined  by 
fundamental  influences  which  override  all  such  artificial  bar- 
riers. 

The  act  permits  only  one  kind  of  banking  business  between 
Reserve  Banks  and  the  general  public.  They  are  allowed  to 
buy  and  sell  to  or  from  individuals,  firms,  and  corporations, 
as  well  as  domestic  and  foreign  banks,  bills  of  exchange  of 
the  kinds  which  are  made  eligible  for  rediscount.  The  pur- 
pose of  this  provision  in  the  act  is  to  enable  the  Reserve  Banks 
to  secure  some  employment  for  their  funds  when  the  demand 
for  rediscounts  slackens,  and  to  develop  a  broad  discount  mar- 
ket. A  broad  discount  market  may  be  developed  under  the 
new  banking  arrangements ;  but  the  prediction  is  ventured  that 
this  provision  in  the  act  will  not  contribute  to  its  development 
and  that  in  general  it  will  be  barren  of  results.  It  should  be 
observed  that  the  promissory  note,  the  usual  borrowing  instru- 
ment in  this  country,  although  it  may  be  used  for  rediscounting 
purposes,  cannot  be  bought  and  sold  in  the  open  market  by 
the  reserve  banks.  Aside  from  foreign  trade,  the  mercantile 
bill  of  exchange,  payable  at  a  future  date,  has  largely  fallen 
into  disuse  in  most  advanced  commercial  countries.  More 
and  more  cash  payments  are  either  insisted  upon,  or  are 
favored  by  the  offer  of  trade  discounts  for  cash  considerably 
greater  than  bank  discounts.  When  a  purchaser  pays  cash, 
obviously  a  mercantile  time  bill  of  exchange  cannot  come  into 
existence.  In  European  countries,  many  purchasers  who  pay 
at  once  often  draw  a  bill  of  exchange  on  their  own  bank  and, 
after  it  has  been  accepted,  discount  it  in  the  open  market.  In 
this  country  banks  are  to  be  allowed  under  the  act  to  accept 
only  bills  drawn  in  connection  with  merchandise  exports  and 
imports.  Material  will,  therefore,  be  lacking  for  a  broad  dis- 
count market,  if  its  development  is  dependent  upon  open  mar- 
ket operations  by  the  Reserve  Banks. 

Fortunately  the  development  of  a  broad  discount  market 
does  not  require  open  market  operations  on  their  part.  A 
broad  discount  market  is  one  to  which  many  borrowers  resort 
with  full  assurance  that  they  will  find  many  lenders.  Even 
under  past  oanking.  arrangements,  many  borrowers  and  lenders 
have  been  brought  together  through  note  brokers;  but  owing 


THE  FEDERAL  RESERVE  ACT          749 

to  the  lack  of  an  available  supply  of  cash  and  credit  with 
which  to  meet  emergencies,  this  market  has  been  subject  to 
violent  perturbations,  and  at  times  dealings  have  been  almost 
entirely  discontinued.  In  the  future  a  solvent  borrower  will 
feel  more  certain  that  his  paper  can  always  be  marketed  by 
his  note  broker;  and  banks  will  purchase  more  largely,  since 
they  will  prefer  to  use  such  paper  for  rediscounting  purposes 
rather  than  that  of  their  own  regular  customers. 

ADDITIONAL   POWERS   OF   NATIONAL   BANKS 

Nearly  half  of  the  national  banks  have  established  savings 
departments  and  now  hold  more  than  eight  hundred  millions 
of  savings  deposits.  This  has  been  a  recent  development,  and 
one  for  which  there  was  no  specific  authority  in  the  national 
banking  law;  but  under  the  liberal  interpretation  of  that  law 
by  the  Comptroller  of  the  Currency  in  recent  years,  it  has  been 
permitted  because  it  was  not  forbidden.  Many  have  doubted, 
however,  whether  the  banks  could  enforce  the  thirty  and  sixty 
days'  notice  of  the  withdrawal  of  deposits  which,  following 
the  practice  of  regular  savings  banks,  appeared  on  the  pass- 
books issued  to  depositors.  This  uncertainty  has  been  re- 
moved by  implication  by  the  new  act,  which  includes  in  its 
definition  of  time  deposits,  savings  accounts  subject  to  at  least 
thirty  days'  notice.  It  is  of  course  a  great  advantage  to  the 
national  banks,  that  in  the  employment  of  these  deposits  they 
are  subject  to  much  less  restriction  than  is  imposed  upon  sav- 
ings banks  in  many  of  the  states. 

Subject  to  the  permission  of  the  Federal  Reserve  Board, 
and  when  not  in  contravention  of  state  laws,  national  banks 
may  act  as  trustees,  executors,  administrators,  and  registrars 
of  stocks  and  bonds.  Many  banks  will  find  this  a  useful  ex- 
tension of  their  powers.  If  trust  companies  may  properly 
engage  in  banking,  there  can  be  no  good  reason  why  banks 
should  not  undertake  trust  functions.  The  department  store 
principle  in  banking  has  made  rapid  headway  in  most  countries 
in  recent  years.  Under  proper  supervision  every  kind  of  rea- 
sonable and  safe  financial  business  can  be  handled  by  a  single 
institution  safely  and  in  a  way  which  is  convenient  for  the  busi- 
ness community.  In  some  states  legislation  may  be  neces- 


750         THE  FEDERAL  RESERVE  SYSTEM 

sary  to  permit  national  banks  to  undertake  trust  functions. 
In  Massachusetts,  it  seems  to  be  the  opinion  among  lawyers 
that  no  legislation  is  required. 

Inability  to  lend  on  mortgage  security  has  been  the  most 
serious  disadvantage  experienced  by  country  national  banks  in 
competition  with  state  institutions.  Land  has  been  by  far 
the  best  local  security  available  over  large  parts  of  the  country. 
Rural  bankers  have,  in  fact,  taken  it  into  account  in  making 
loans  and  by  various  devices  have  succeeded  in  making  it  the 
security  for  many  of  the  loans  which  they  have  granted.  Un- 
der the  Federal  Reserve  Act  all  banks,  except  those  in  central 
reserve  cities,  may  lend  for  periods  not  exceeding  five  years 
25  per  cent,  of  their  capital  and  surplus,  or  one-third  of  their 
time  deposits,  on  the  security  of  unencumbered  and  improved 
farm  land  to  50  per  cent,  of  its  market  value. 

Two  changes  are  made  in  the  law  for  the  purpose  of 
facilitating  financial  business  with  foreign  countries.  National 
banks  having  a  capital  of  at  least  one  million  dollars  may 
establish  foreign  branches,  subject  to  the  approval  of  the 
Federal  Reserve  Board,  and  to  such  regulations  as  it  may 
formulate  for  conducting  this  business.  Banks  may  also  ac- 
cept bills  of  exchange  maturing  within  six  months  drawn  in 
connection  with  exports  and  imports  of  merchandise.  These 
are  desirable  changes  in  the  law.  It  is  not,  however,  prob- 
able that  many  foreign  branches  will  be  established  in  the  near 
future,  and  it  is  most  unlikely  that  the  American  acceptance 
will  make  rapid  headway  in  foreign  markets. 

The  scope  of  the  following  provision  in  the  act  is  uncertain. 
"  Other  than  the  usual  salary  or  director's  fee  paid  to  any  of- 
ficer, director,  or  employee  of  a  member  bank,  and  other  than  a 
reasonable  fee  paid  by  said  bank  to  such  officer,  director,  or 
employee  for  services  rendered  to  such  bank,  no  officer,  di- 
rector, employee,  or  attorney  of  a  member  bank  shall  be  a  bene- 
ficiary of,  or  receive,  directly  or  indirectly,  any  fee,  commis- 
sion, gift,  or  other  consideration  for  or  in  connection  with 
any  transaction  or  business  of  the  bank."  This  prohibition 
obviously  covers  payments  to  bank  directors  and  officers  in 
return  for  aid  in  securing  accommodation  from  the  banks. 
It  may  be  held  that  all  purchases  by  a  bank  of  commercial 


THE  FEDERAL  RESERVE  ACT  751 

paper  from  a  firm  of  note  brokers,  or  of  securities  from  a 
banking  house,  are  forbidden  if  any  of  the  partners  of  such 
firms  are  on  its  board  of  directors.  In  this  event,  a  few  banks 
would  lose  valuable  directors;  but  the  question  of  the  wisdom 
of  such  exclusion  is  too  complex  to  be  given  consideration  in 
this  paper.1 

SUPERVISORY   FUNCTIONS   OF  THE   FEDERAL   RESERVE 
BOARD 

A  variety  of  functions  of  a  supervisory  or  administrative 
nature  are  to  be  exercised  by  the  Federal  Reserve  Board.  It 
is  to  formulate  detailed  regulations  regarding  various  matters 
concerning  which  only  general  provisions  are  contained  in  the 
act.  Among  important  matters  regarding  which  the  Board 
is  to  formulate  regulations  may  be  mentioned :  rules  for  con- 
ducting branch  offices ;  the  regulation  of  state  banks  which  be- 
come member  banks ;  rules  defining  precisely  commercial  loans 
eligible  for  rediscount;  and  the  regulations  for  the  operation 
of  foreign  branches.2  The  Board  is  to  exercise  many  super- 
visory functions  over  the  reserve  banks  which  are  similar  to 
those  which  have  long  been  exercised  by  the  Comptroller  of 
the  Currency  over  the  national  banks.  Examination  of  the 
Reserve  Banks  is  under  its  direction.  There  must  be  one  ex- 
amination each  year,  and  additional  examinations  must  be  or- 
dered upon  the  application  of  ten  member  banks.3  The  Board 
is  also  to  publish  once  each  week,  a  statement  showing  the  con- 
dition of  each  Reserve  Bank,  and  a  consolidated  statement  for 
all  these  institutions.  It  is  also  given  a  number  of  important 
powers  to  be  exercised  at  its  discretion.  It  may  suspend  re- 
serve requirements  for  a  period  of  thirty  days,  and  renew  such 

1  The  inability  of  the  Pujo  money  trust  committee  to  secure  desired  in- 
formation from  the  banks  evidently  occasioned  the  following  clause :  "  No 
bank  shall  be  subject  to  any  visitatorial  powers  other  than  such  as  are 
authorized  by  law,  or  vested  in  the  courts  of  justice,  or  such  as  shall  be  or 
shall  have  been  exercised  or  directed  by  Congress,  or  by  either  House 
thereof,  or  by  any  committee  of  Congress  of  either  House  duly  authorized." 

2  [Several  of  the  more  important  regulations  of  the  Federal   Reserve 
Board  are  contained  in  Appendix  B.] 

3  The  law  regarding  the  examination  of  national  banks  is  recast.     The 
only  important  changes  are  that  hereafter  all  examiners  are  to  be  paid 
salaries,  and  that  the  Federal  Reserve  Banks  are  empowered  to  conduct 
special  examinations  of  member  banks. 


752         THE  FEDERAL  RESERVE  SYSTEM 

suspension  for  successive  fifteen  day  periods.  For  violations 
of  law,  it  may  suspend  the  operation  of  a  reserve  bank,  and 
administer  or  liquidate  it.  The  Board  may  also  reclassify 
cities  as  reserve  or  central  reserve  cities,  or  terminate  their 
designation  as  such. 

The  method  of  banking  reform  which  has  now  been  adopted, 
necessarily  involves  placing  somewhere  enormous  power  to 
expand  credit.  This  power  cannot  be  surrounded  by  sufficient 
safeguards  to  prevent  all  possibility  of  its  misuse,  because  in  so 
doing,  its  wise  use  would  be  quite  as  seriously  interfered  with. 
Competent  management  is  therefore  absolutely  essential  if 
satisfactory  results  are  to  follow  the  passage  of  the  Federal 
Reserve  Act.  In  the  operation  of  the  new  system,  the  boards 
of  directors  of  the  reserve  banks  may  prove  the  most  im- 
portant part  of  the  organization;  or  that  place  may  be  oc- 
cupied by  the  Federal  Reserve  Board.  The  boards  of  di- 
rectors will  exercise  all  the  ordinary  powers  of  such  boards, 
except  in  so  far  as  they  are  subject  to  control  by  the  Board. 
All  the  loans  of  the  Reserve  Banks  are  to  be  made  by  the  boards 
of  those  banks.  In  this  matter,  the  Board  has  no  power  what- 
ever, except  that  it  may  require,  on  the  affirmative  vote  of  five 
members,  one  Reserve  Bank  to  rediscount  paper  for  others. 
Here  is  a  power  that  seems  to  be  designed  merely  to  prevent 
any  working  at  cross  purposes  among  the  Reserve  Banks. 
Few  or  no  occasions  for  its  use  will  present  themselves  if  all 
the  Reserve  Banks  are  well  managed  by  their  own  boards.  All 
rates  of  discount  are  to  be  fixed  in  the  first  instance  by  the 
boards,  subject  to  review  and  determination  by  the  Federal 
Board.  Here  again  the  decision  of  the  Reserve  Bank  boards 
is  altogether  unlikely  to  be  overruled  if  these  banks  are  skil- 
fully managed. 

The  power  of  the  Federal  Reserve  Board  to  restrain  the 
Reserve  Banks  is  vastly  greater  than  its  power  to  force  them 
to  take  positive  action  which  might  lead  to  the  inflation  of 
credit.  This  was  clearly  the  purpose  in  view  in  giving  the 
Board  the  more  important  of  its  many  powers.  It  may,  for 
example,  reject  applications  of  Reserve  Banks  for  notes,  but 
this  will  not  endanger  assets,  it  will  simply  lessen  power  to 
expand  operations.  Its  power  over  the  discount  rates  of  Re- 


THE  FEDERAL  RESERVE  ACT 


753 


754  THE  FEDERAL  RESERVE  SYSTEM 

serve  Banks  will  obviously  be  more  effective  when  used  to  ad- 
vance rates  which  it  deems  too  low  than  it  will  be  if  used  to 
enforce  a  rate  lower  than  the  management  approves.  The  di- 
rectors of  the  Reserve  Bank  would  still  determine  the  amount 
of  accommodation  which  it  might  safely  grant  to  member 
banks  at  the  enforced  low  rate.  Officers  and  directors  of  Re- 
serve Banks  may  be  removed  at  any  time  by  the  Federal  Board, 
which  is  merely  required  to  communicate  its  reasons  for  re- 
moval in  writing;  but  the  right  of  member  banks  to  choose 
successors  will  still  remain. 

While  it  is  impossible  to  make  any  prediction  as  to  the  rela- 
tive place  which  the  Reserve  Bank  directors  and  the  Federal 
Board  will  hold,  it  is  evident  that,  in  the  absence  of  harmon- 
ious cooperation,  the  system  will  not  work  smoothly,  even  if 
it  can  be  made  to  work  at  all.  If  all  the  Reserve  Banks  and 
the  Federal  Board  adopt  a  wise  and  conservative  policy,  the 
system  will  surely  work  well.  If  the  Reserve  Banks  alone  are 
conservative,  the  system  may  work  well  but  with  much  friction. 
If  the  Federal  Board  alone  is  conservative,  it  may  force  good 
results  from  the  system.  On  the  other  hand,  if  some  of  the 
Reserve  Banks  and  the  Federal  Board  are  reckless,  the  system 
will  probably  break  down;  and  if  all  the  Reserve  Banks  and 
the  Federal  Board  adopt  a  reckless  policy,  the  results  will  be 
disastrous. 

Both  the  directors  of  Reserve  Banks,  and  the  Federal  Board 
will  be  confronted  with  numerous  problems,  many  novel  and 
some  intricate.  The  possibilities  of  the  new  system  cannot  be 
foreseen,  and  the  extent  and  nature  of  the  responsibilities  rest- 
ing upon  the  Reserve  Banks  cannot  be  determined  before- 
hand. 


THE  FEDERAL  RESERVE  ACT  —  AN  EXPERIMENT 

1  Banking  is  the  rgost  delicate  and  sensitive  of  all  businesses 
in  which  men  engage.  It  goes  without  saying  that  it  is  a  busi- 
ness in  which  the  law  maker  should  not  needlessly  interfere. 

1  Adapted  from  Joseph  French  Johnson,  Fundamental  Weakness  of  the 
Glass-Owen  Bill,  an  address  delivered  before  the  Economic  Club  of  New 
York  City,  Monday  evening,  November  10,  1913. 


THE  FEDERAL  RESERVE  ACT          755 

Perhaps  some  of  you  may  not  know  that  modern  banking  is  a 
product  of  evolution.  In  this  respect  it  is  like  all  great  human 
institutions.  No  language  worth  while  was  ever  invented  by  a 
human  being.  Speech,  with  all  its  intricacies  and  inconsis- 
tencies of  grammar  and  syntax,  was  not  planned  by  some 
master  mind  centuries  ago,  but  is  the  result  of  countless  ages 
of  effort  on  the  part  of  the  human  animal,  guided  only  by  his 
sub-conscious  intelligence  —  that  which  we  call  instinct  in  the 
lower  animals  —  to  give  expression  to  his  emotions  and  his 
more  or  less  hazy  concepts.  Language,  like  the  comb  in  which 
the  bee  stores  its  honey,  has  come  to  us  as  the  product  of 
the  labor  of  our  ancestors  through  many  millions  of  years. 
Money,  credit,  and  banking  are  in  like  manner  evolutionary 
products.  If  we  attempt  to  tinker  with  them  artificially  with- 
out regard  to  the  lessons  of  experience  and  in  disregard  of  the 
forces  of  evolution,  believing  that  our  reason  transcends  the 
consolidated  experience  of  our  ancestry,  we  shall  meet  the  fate 
that  we  deserve,  the  fate  of  the  conceited  bee  who  thinks  he 
can  improve  the  honey  comb,  or  of  the  conceited  grammarian 
who  would  make  me  walk  a  literary  Bridge  of  Sighs  for  saying 
"  it  is  me."  .  .  . 

I  am  quite  willing  to  admit  that  in  some  of  its  details  the 
Federal  Reserve  Act  J  has  taken  leaves  from  the  experience  of 
banking  institutions  of  this  and  other  countries,  but  in  its 
essentials,  in  its  anatomy,  in  its  bony  structure  as  it  has  been 
called,  it  is  an  animal  absolutely  unknown  to  the  natural  his- 
tory of  finance.  Let  me  briefly  call  attention  to  the  following 
novelties  in  banking: 

First.  It  provides  for  a  system  of  twelve  competing  banking 
institutions  which  shall  control  the  currency  supply  of  this 
country,  and  over  which  there  shall  be  no  controlling  body  with 
power  sufficient  to  compel  them  to  regard  the  national  welfare 
in  the  issue  of  currency  and  in  the  extension  of  their  credit. 
It  is  taken  for  granted  that  the  financial  welfare  of  the  people 

1  Although  the  address  in  part  here  reproduced  was  delivered  as  a 
criticism  of  the  Glass-Owen  Bill,  one  of  the  measures  that  led  up  to  the 
passage  of  the  Federal  Reserve  Act,  that  criticism,  as  a  result  of  a  few 
slight  changes  made,  applies  with  almost  equal  force  to  the  Federal  Re- 
serve Act  itself.  The  preceding  article  hy  Professor  Spragne  answers  with 
Striking  directness  Professor  Johnson's  trenchant  argument.— EDITOR. 


756         THE  FEDERAL  RESERVE  SYSTEM 

will  be  safe  provided  that  these  competing  regional  banks  are 
required  to  hold  gold  or  lawful  money  reserves  of  35  per  cent, 
against  deposits  and  40  per  cent,  gold  (free  from  tax)  against 
notes,  and  are  not  permitted  to  issue  notes  except  upon  deposit 
of  good  commercial  paper.1 

Second.  The  act  provides  that  the  Federal  Reserve  Banks 
shall  have  the  right  to  deal  only  with  banks,  nay  more,  they 
may  deal  only  with  such  banks  as  have  contributed  to  their 
capital  stock.  This  again  is  a  novelty  in  the  banking  world. 
If  these  banks  are  to  be  in  touch  with  all  American  business 
and  industry  and  be  powerful  agents  for  the  prevention  and 
alleviation  of  panic,  why  should  they  be  thus  restricted  in  their 
operations  ? 

Third.  The  capital  of  these  regional  banks  is  not  a  matter 
of  voluntary  subscription.  It  is  not  founded,  on  business 
principles.  The  framers  of  the  measure  seemed  to  fear  lest 
the  banks  they  were  planning  might  not  prove  profitable  in- 
vestments, hence,  they  have  provided  that  our  national  banks 
must  subscribe  the  necessary  capital  or  forfeit  their  charters. 
No  country  on  this  green  and  prosperous  earth  has  ever  found 
it  necessary  to  resort  to  such  undemocratic  compulsion  in  order 
to  persuade  people  to  go  into  the  profitable  business  of  banking. 

Fourth.  The  bank  notes  issued  by  these  Federal  Reserve 
Banks  are  called  government  obligations  and  must  be  redeemed 
on  demand  by  the  United  States  Treasury.  In  no  country 
will  you  find  that  any  such  bank  note  has  ever  been  issued  or 
even  proposed,  and  I  submit  that  in  the  United  States,  whose 
people  for  half  a  century  have  confessedly  been  subject  to 
periods  of  anxiety  and  distress  and  panic  because  of  the 
Government's  liability  for  the  daily  redemption  of  paper 
money,  this  provision  of  the  Federal  Reserve  Act  is  amazing, 
inexplicable,  and  indefensible.  The  United  States  Treasury  is 
not  a  bank  and  is  not  made  one  by  this  act.  It  cannot  control 
the  issue  of  the  notes,  nor  the  credit  operations  of  the  banks 
who  do  issue  them.  Why  then  should  the  treasury  be  com- 
pelled to  redeem  these  notes? 

1  [It  is  commonly  held  that  ample  controlling  power  has  been  conferred 
upon  the  Federal  Reserve  Board  by  the  act  as  finally  passed.  It  is  of 
interest  that  Senator  Owen  listened  to  the  address  of  which  an  adapta- 
tion is  here  given.] 


THE  FEDERAL  RESERVE  ACT          757 

Fifth.  The  Federal  Reserve  Act  provides  for  an  arbitrary 
shifting  of  bank  reserves  such  as  has  never  been  attempted 
before.  Nobody  can  foretell  what  the  result  will  be,  but  we 
know  nothing  of  the  sort  has  ever  been  attempted  before 
and  we  also  know  that  many  banks  will  be  obliged  to  re- 
duce their  loans  and  discounts,  and  that  their  customers,  the 
business  men  of  the  country,  may  suffer  serious  losses  in  conse- 
quence. 

The  United  States  has  tried  many  financial  experiments  — 
indeed,  our  present  national  banking  system  was  an  experiment 
in  finance  and  has  been  found  wanting  —  but  the  Federal  Re- 
serve Act,  if  it  could  be  put  on  exhibition  in  a  world's  financial 
museum,  would,  I  feel  sure,  be  voted  the  newest  and  most 
spectacular  thing  we  have  yet  constructed. 


1  Beneath  his  skin  every  American  citizen  of  every  station 
and  avocation,  and  whatever  party  name  he  may  wear,  is  a 
Democrat  in  all  the  essentials  and  fundamentals.  That  is,  he 
is  attached  passionately  to  the  principles  of  local  self-govern- 
ment, of  the  widest  individual  liberty  compatible  with  the 
general  weal  and  order  of  society.  This  new  currency  meas- 
ure is  democratic  essentially.  It  looks  to  decentralisation  of 
direct  financial  control,  to  financial  local  self-government,  so 
far  as  is  consistent  with  stability  and  the  general  safety;  to  a 
currency  which  will  be  worth  its  face  value  everywhere,  which 
will  be  based  on  the  actual  values  it  purports  to  represent,  as 
well  as  the  faith  and  credit  of  the  General  Government,  and 
which  yet  will  be  elastic,  expanding  to  meet  needs  where  and 
when  they  develop,  receding  when  not  needed ;  a  system  fitted 
to  meet  any  emergency,  moving  smoothly  and  noiselessly  for 
the  ordinary  uses  of  business  in  tranquil  times. 

Too  much  money  and  too  little  money  are  alike  evil  and 

1  John  Skelton  Williams,  Comptroller  of  the  Currency,  "  Democracy  in 
Banking,"  an  address  delivered  before  the  annual  convention  of  the  North 
Carolina  Bankers'  Association  in  the  House  of  Representatives  at  the 
capitol  at  Raleigh,  May  13,  1914.  Printed  in  Congressional  Record,  63d 
Congress,  2d  Session,  Vol.  51,  pp.  10150-53. 


758  THE  FEDERAL  RESERVE  SYSTEM 

dangerous.  Opinions  differ  as  to  which  is  the  worse.  Prob- 
ably one  is  as  bad  as  the  other.  The  design  of  the  new  law 
is  to  supply  just  enough  money  or  credit,  when  and  where 
business  needs  it,  to  create  for  our  commerce,  as  has  been 
said,  foundations  so  even,  so  broadly  laid,  and  so  deeply  planted 
that  they  can  not  be  shaken. 

As  it  is,  the  country  bleeds  and  sweats  to  the  big  financial 
centres.  Take  the  South  as  an  instance  —  and  the  conditions 
with  which  you  here  in  North  Carolina  are  familiar  exist 
everywhere  in  the  country.  Most  of  our  railway  systems  are 
controlled  frequently  through  the  trust  known  as  the  voting 
trust  —  by  men  who  are  interested  in  the  great  banks  in  the 
three  central  reserve  cities.  So  it  happens  that  the  large  de- 
posits of  the  railways,  their  collections  from  the  Southern  peo- 
ple, as  also  from  the  Western  people,  are  sent  on  largely  to 
those  banks.  The  same  is  true  of  the  telegraph  and  telephone 
companies,  the  life  and  fire  insurance  companies,  and  of  many 
of  the  larger  manufacturing  enterprises.  The  merchants  and 
manufacturers  of  North  Carolina  pay  their  freight  bills  to  the 
railways.  The  money  goes  largely  and  promptly  to  New 
York,  and  is  lent  out  and  used  there  in  stock-market  opera- 
tions, or  as  the  directors  of  the  banks,  who  are  also  often  the 
directors  of  the  roads  and  other  corporations,  may  elect.  Of 
course  there  is  no  law  which  provides  for  the  carrying  of  the 
reserves  and  bank  balances  of  railways  and  industrial  corpora- 
tions in  the  central  reserve  cities,  where  the  national  banks 
of  the  country  have  also  been  accustomed  to  keep  their  re- 
serves. 

When  North  Carolina  needs  money  to  move  the  cotton  crop 
her  banks  must  call  on  New  York  for  money  which  should  be 
in  their  own  vaults;  for  the  return  of  money  paid  in  here  in 
freight  bills,  insurance  premiums,  and  otherwise;  and  your 
banks  sometimes  think  themselves  lucky  if  they  can  be  allowed 
the  use  of  any  part  of  it.  ... 

It  is  not  hard  to  see  how  centralization  of  financial  resources 
and  money  supply  and  concentration  of  financial  power  has 
been  forced,  and  the  invisible  and  irresponsible  despotism 
created  by  acts  of  Congress  and  policies  of  government  made 
necessary  by  those  acts. 


THE  FEDERAL  RESERVE  ACT          759 

Now,  we  do  not  propose  to  use  violence  to  force  disintegra- 
tion and  decentralization,  to  do  anything  with  a  jolt  and  a 
jerk.  It  is  understood  clearly  that  to  rush  headlong  and  at 
full  speed  over  an  evil  or  an  obstacle  may  cause  derailment  or 
jarring,  uncomfortable  and  bad  for  passengers.  The  thought 
or  plan,  as  I  understand  it,  is  to  invite  decentralization,  to  en- 
courage it,  to  give  opportunity  for  it,  to  make  local  self- 
government  possible,  to  remove  the  influences  which  draw  to  a 
few  centres  the  money  that  is  paid  out  to  the  corporations  and 
deposited  in  the  local  banks.  .  .  . 

The  law  does  not  require  a  single  business  man  to  change 
his  account  from  the  bank  with  which  he  has  kept  it  or  any 
business  man  or  bank  to  suspend  dealings  with  the  bank  or 
banks  in  the  central  reserve  or  reserve  cities  with  which  they 
have  in  the  past  been  doing  business.  It  does  offer  to  banks 
freedom  of  choice.  It  says  to  the  banker  that  he  can  follow 
his  preferences,  sentiments,  or  habit  in  selecting  the  source  of 
his  borrowing;  and  the  member  banker  of  any  federal  reserve 
district  may  feel  free  and  peaceful  and  at  ease  when  he  knows 
that  he  has  in  his  portfolio  notes,  drafts,  and  bills  of  exchange 
arising  out  of  actual  commercial  transactions,  which  he  can 
convert  into  money  at  his  federal  reserve  bank  with  greater 
ease  and  promptness  than  it  has  sometimes  been  possible  for 
him  to  withdraw  his  cash  balances  from  his  reserve  agents 
and  almost  with  as  much  ease  as  it  has  ever  been  possible  to 
draw  on  credit  balances  with  any  correspondent.  He  is  not 
dependent  on  the  whims  or  fortunes  of  any  other  bank.  He 
need  not  shiver  at  the  prospect  of  abundant  crops  for  fear  he 
may  not  have  available  the  funds  with  which  to  meet  demands 
for  moving  them.  He  will  know  that  if  he  needs  money  to 
accommodate  the  bank's  customers  he  can,  as  a  matter  of  right, 
call  on  his  federal  reserve  bank. 

Among  other  benefits  the  new  currency  law,  by  its  direct 
system  of  clearances,  will  release  and  make  available  for  pur- 
poses of  trade  and  commerce  hundreds  of  millions  of  dollars 
which  under  the  old  system  have  been  tied  up  in  tedious 
processes  of  collection.  It  will  also  save  to  banks  and  to  mer- 
chants and  business  men  generally  some  millions  of  dollars 
which  they  are  now  paying,  directly  and  indirectly,  for 


760  THE  FEDERAL  RESERVE  SYSTEM 

the  collection  of  country  checks  and  checks  on  outside 
cities. 

To  refer  more  particularly  to  your  own  district,  the  fifth,  I 
will  try  to  explain  to  you  how  the  new  method  will  work  in 
transactions  of  domestic  exchange. 

In  this  district,  embracing  the  States  of  North  and  South 
Carolina,  Virginia,  West  Virginia  (except  four  counties),  the 
District  of  Columbia,  and  Maryland,  there  are  some  475  mem- 
ber banks. 

A  cotton  mill  at  Columbia,  S.  C,  under  the  old  plan  sends 
its  check  on  its  Columbia  bank  for  a  shipment  of  coal  to  the 
coal  company  at  Bluefield,  W.  Va.  The  local  bank  at  Blue- 
field  forwards  this  check  to  its  correspondent  in  Richmond. 
This  correspondent  sends  the  check  to  its  own  correspondent 
in  Columbia,  who  makes  the  collection  from  the  Columbia 
bank  and  then  draws  a  check  on  New  York  for  New  York 
exchange,  which  it  remits  to  Richmond.  The  Richmond  bank 
thereupon  notifies  the  Bluefield  bank  of  the  collection  of  the 
item.  The  collection  and  exchange  charges  on  distant  country 
banks  amount  usually  to  from  one-tenth  to  one- fourth  of  i  per 
cent.,  or  possibly  more,  and  probably  a  week  or  more  elapses 
between  the  remittance  of  the  South  Carolina  check  to  the 
Bluefield  bank  and  the  time  when  the  Bluefield  bank  gets  its 
report  that  the  item  has  been  collected  and  placed  to  its  credit 
in  Richmond. 

Under  the  new  currency  act  "  every  Federal  Reserve  Bank 
shall  receive  on  deposit  at  par  from  member  banks  .  .  . 
checks  and  drafts  drawn  upon  any  of  its  depositors."  That 
means  that  the  Bluefield  bank  receiving  the  check  on  the 
Columbia,  S.  C.,  bank  mails  it  to  the  federal  reserve  bank 
at  Richmond.  The  federal  reserve  bank  at  Richmond  there- 
upon charges  the  Columbia  bank  with  the  amount  of  the 
check,  credits  the  Bluefield  bank  with  the  proceeds,  and  no- 
tifies the  two  banks  accordingly. 

The  Federal  Reserve  Act  also  provides  that  each  federal 
reserve  bank  shall  receive  at  par,  and  credit  accordingly,  all 
checks  and  drafts  drawn  upon  any  of  its  member  banks, 
from  every  other  federal  reserve  bank;  that  all  checks  and 
drafts  drawn  by  any  depositor  —  that  is  to  say,  by  any  member 


THE  FEDERAL  RESERVE  ACT          761 

bank  —  on  any  federal  reserve  bank  shall  be  received  and 
credited  at  par  by  every  other  federal  reserve  bank.  This 
means  that  the  checks  of  the  member  banks  in  the  country 
towns  throughout  these  five  States  are  worth  their  full  face 
value,  without  deduction  for  exchange  or  collection  charges, 
to  every  other  member  bank,  and  that  the  amount  of  each 
check  may  be  cashed  at  par  immediately,  without  following 
the  devious  and  roundabout  courses  now  observed  in  the  col- 
lection of  checks.  Virtually  every  bank  in  the  fifth  district 
is  only  one  night  distant  from  Richmond,  and  a  check  mailed 
one  afternoon  in  the  most  distant  portions  of  the  dis- 
trict should  reach  Richmond  the  following  day  in  time 
to  be  included  in  that  day's  operations  of  the  federal  reserve 
bank. 

Let  us  now  consider  another  aspect  of  the  new  law :  Under 
the  old  National  Bank  Act  a  national  bank  with  a  capital  of, 
say,  $200,000,  deposits  of,  say,  $1,500,000,  bills  receivable 
amounting  to  $1,200,000,  and  $300,000  reserve,  would  only 
be  permitted  to  borrow  a  total  of  $200,000,  the  amount  of  its 
capital.  If  a  run  should  start  on  such  a  bank,  the  amount 
which  it  could  raise  by  loans,  if  strictly  held  to  the  old  law, 
would  be  but  $200,000,  the  amount  of  its  capital,  which  might 
be  quite  inadequate  to  meet  a  run,  and  the  bank,  though 
thoroughly  solvent,  might  be  forced  to  suspend. 

Under  the  new  law,  however,  if  a  bank  with  $200,000 
capital  and  deposits  of  $1,500,000  should  have  loaned  $i,- 
200,000  to  its  customers  on  commercial  paper  and  should  en- 
counter an  unexpected  run,  in  addition  to  borrowing  $200,000, 
the  amount  of  its  capital,  such  a  bank  would  have  authority  to 
rediscount  with  the  federal  reserve  bank  of  which  it  is  a  mem- 
ber, notes,  drafts,  and  bills  of  exchange  issued  or  drawn  for 
agricultural,  industrial,  or  commercial  purposes,  having  not 
more  than  ninety  days  to  run,  to  any  reasonable  extent  which 
may  be  approved  by  the  federal  reserve  bank  to  which  applica- 
tion for  such  rediscounts  may  be  made.  .  .  . 

We  can  not  overestimate  the  value  of  the  additional  security 
which  this  provision  of  the  act  confers  upon  every  honestly, 
capably  managed  member  bank,  and  the  relief  from  strain  and 
anxiety  and  from  the  fear  and  apprehension  of  panics  and 


762         THE  FEDERAL  RESERVE  SYSTEM 

unreasoning  rims  which  it  gives  to  the  officers  of  every  mem- 
ber bank. 

Another  important  change  provided  by  the  Federal  Reserve 
Act  is  the  new  arrangement  for  the  compensation  of  national 
bank  examiners.  Under  the  present  law  the  compensation  of 
national  bank  examiners  is  based,  except  as  to  reserve  cities, 
on  the  capital  stock  of  the  bank  examined.  Under  the  opera- 
tions of  this  law  a  national  bank  examiner  has  been  receiving 
for  the  examination  of  a  certain  national  bank  in  the  fifth  dis- 
trict, with  over  $9,000,000  of  assets  and  many  thousands  of 
accounts,  the  munificent  sum  of  $25.  It  is,  of  course,  clear 
that  an  examiner  could  make  only  an  imperfect  examination  of 
such  a  bank  in  the  space  of  three  days  at  a  compensation  of, 
say,  $8  per  day,  out  of  which  $8  allowance  he  has  to  pay  his 
own  railroad  fare,  hotel  expenses,  as  well  as  clerical  assistance. 
It  is  not  unnatural  that  but  few  examiners  would  willingly 
spend  the  ten  days  or  two  weeks  which  it  might  require  to 
make  a  thorough  examination  of  such  a  bank  when  he  is  run- 
ning personally  in  debt  in  doing  so. 

Under  the  new  currency  law  the  Federal  Reserve  Board, 
upon  the  recommendation  of  the  Comptroller  of  the  Currency, 
is  given  authority  to  fix  the  compensation  of  bank  examiners 
on  the  basis  of  annual  salary,  so  that  those  banks  which  need 
additional  time  and  attention  from  the  examiner  may  receive 
the  careful,  close  scrutiny  which  the  case  may  call  for.  It  is 
believed  that  the  new  system  of  bank  examinations  will  reduce 
materially  the  number  of  bank  failures  and  enable  the  depart- 
ment to  check  up  many  abuses  and  correct  many  evil  situations 
which  in  the  past  have  been  ignored  or  glossed  over  by  examin- 
ers in  their  hasty  and  incomplete  investigations. 

I  thank  you,  gentlemen,  for  the  opportunity  to  address  you. 
Approaching  the  study  of  this  new  and  revolutionary  measure 
with  the  caution  natural  to  every  man  trained  in  banking  under 
the  system  with  which  we  have  grown  up,  I  have  become  more 
thoroughly  aroused  to  its  merits  and  more  deeply  impressed 
as  I  have  watched  the  methods  of  construction,  the  processes 
of  growth,  and  have  considered  the  underlying  principles  di- 
recting those  who  did  the  work. 


ELASTICITY  OF  NOTE  ISSUE  763 

THE  ELASTICITY  OF  NOTE  ISSUE  UNDER  THE  NEW 
CURRENCY  LAW1 

To  anyone  who  has  been  interested  in  currency  reform  for, 
say,  twenty  years,  probably  nothing  is  more  striking  than  the 
change  in  emphasis  which  has  taken  place  among  the  advocates 
of  reform  during  this  period.  The  typical  reform  plan  of  the 
earlier  time,  for  example  the  so-called  Baltimore  plan  brought 
forward  in  1894,  devoted  itself  almost  exclusively  to  providing 
a  thoroughly  elastic  note  issue,  based  on  ordinary  assets.  In 
contrast,  the  new  law  has  as  its  central,  primary  object  the 
organization  into  at  least  regional  unity  of  something  like  the 
entire  banking  system  of  the  country.  Doubtless  this  differ- 
ence in  the  two  reform  plans  was  not  altogether  due  to  a  funda- 
mental difference  of  opinion  with  respect  to  what  would  be 
the  ideal  scheme.  The  reformers  of  the  earlier  period  were 
not  indifferent  to  the  need  for  centralized  organization  in  the 
banking  system.  But  they  considered  any  scheme  involving 
a  central  bank,  like  the  old  Bank  of  the  United  States,  quite 
chimerical ;  and  they  were  probably  right.  But  times  change ; 
and  men  change  with  them.  For  one  reason  or  another  we 
have  all  become  more  tolerant  of  centralization  in  business 
matters,  as  also  more  tolerant  of  that  increase  in  governmental 
control  which  increased  centralization  in  business  seems  to 
make  necessary.  With  at  least  fairly  general  approval,  a  sys- 
tem of  regional  organization  has  been  set  up,  involving  a  very 
high  degree  of  centralization  and  a  very  high  degree  of  govern- 
mental control.  But  with  this  change  in  the  method  of  re- 
form, it  became  inevitable  that  the  more  important  ends  which 
earlier  schemes  sought  to  accomplish  by  giving  the  note  a  high 
degree  of  elasticity  should  be,  in  no  small  measure,  attained  by 
other  means.  In  consequence,  the  need  for  elasticity  in  the 
note  issue  will  be  much  diminished  under  the  new  law. 
Nevertheless,  it  is  admitted  that  this  need  will  not  disappear 
altogether.  Elasticity  in  the  note  issue  will  be  wanted  partly 
to  assist  in  utilizing  the  newer  methods  of  dealing  with  the 

1  F.  M.  Taylor,  The  Elasticity  of  Note  Issue  under  the  New  Currency 
Law.  The  Journal  of  Political  Economy,  Vol.  22,  No.  5,  May,  1914,  pp. 
453-463. 


764         THE  FEDERAL  RESERVE  SYSTEM 

difficulties  involved  and  partly  to  supplement  those  newer 
methods.  Accordingly,  the  question  "  How  far  does  the  note 
issue  under  the  new  system  seem  likely  to  prove  an  elastic 
one  ?  "  is  still  important. 

From  the  beginnings  of  agitation  for  currency  reform  the 
advocates  of  elasticity  have  recognized  more  or  less  clearly  two 
kinds :  ( I )  what  we  may  call  seasonal  or  ordinary  elasticity, 
and  (2)  what  we  may  call  emergency  elasticity.  By  the  for- 
mer was  meant  the  power  of  a  note  issue  to  adjust  its  volume 
to  those  moderate  changes  in  the  need  for  money  which  show 
themselves  in  the  course  of  an  ordinary  year.  By  emergency 
elasticity  was  meant  the  power  of  a  note  issue  to  adjust  its 
volume  to  those  extraordinary  changes  in  need  which  connect 
themselves  with  the  typical  banking  panic.  The  evils  which 
it  was  believed  that  seasonal  or  ordinary  elasticity  would 
remedy  were  principally  (i)  the  summer  shortage  of  currency 
for  moving  crops,  together  with  the  temporary  but  more  or 
less  serious  stringency  in  the  New  York  money  market  which 
accompanies  that  shortage,  and  (2)  the  plethora  or  excess  of 
currency  which  usually  appears  three  or  four  months  after  the 
crop-moving  period  has  terminated.  The  evils  which  emer- 
gency elasticity  was  expected  to  relieve  were  principally  (i) 
the  stringency  which  precipitates  the  panic,  (2)  the  money 
famine  consequent  on  general  bank  suspension  after  the  panic 
has  fully  developed,  and  (3)  the  glut  of  currency  which  at- 
tends the  depression  following  a  panic,  often  leading  to  ex- 
cessive exports  of  gold  and  thus  endangering  the  whole  credit 
system  of  the  country. 

Let  us,  now,  take  up  seasonal  or  ordinary  elasticity,  and  ask 
ourselves  whether  the  new  notes  are  likely  to  possess  this 
characteristic.  First,  how  about  the  expansibility  needed  to 
supply  adequate  funds  for  crop-moving?  At  this  point,  it 
must  at  once  be  admitted  that  the  new  currency  does  not  meet 
the  demands  of  the  case  in  quite  the  thoroughgoing  way 
,  which  the  earlier  schemes  thought  to  be  necessary.  The  ideal 
of  the  earlier  plans  was  to  provide  an  adequate  and  easily 
utilized  power  of  issue,  located  at  the  very  place  where  the 
need  for  expansion  is  felt,  i.  e.,  in  the  local  bank.  The  new 
law  gives  up  this  idea  entirely.  The  local  bank  will  not  have 


ELASTICITY  OF  NOTE  ISSUE  765 

power  to  issue  the  new  currency  at  all.  In  so  far  as  its  cus- 
tomers are  to  get  any  benefit  from  that  currency  the  benefit 
must  come  through  two  channels  which  the  country  bank  could 
use  in  getting  the  needed  funds,  even  if  the  currency  had  no 
expansibility,  namely,  (i)  calling  in  its  balances  kept  with 
banks  more  centrally  situated,  and  (2)  borrowing  from  such 
central  banks.  In  other  words,  the  new  power  of  issue  will 
help  out  in  the  crop-moving  period  merely  because  it  will  put 
the  reserve  banks  in  a  better  position  to  respond  to  the  call 
of  the  country  banks  for  the  return  of  their  own  balances  and 
for  advances  on  discounted  paper.  Judged  from  this  point 
of  view  only,  the  elasticity  provided  by  the  new  law  is  doubt- 
less adequate.  If  the  reserve  banks  have  not  kept  themselves 
in  a  position  to  meet  the  calls  of  their  country  members  from 
money  already  in  possession,  they  will  surely  be  able  to  put 
themselves  into  such  a  position  by  expanding  their  issue  of 
notes.  In  one  sense,  then,  the  new  issue  has  adequate  ex- 
pansibility for  ordinary  needs.  There  still  perhaps  remains  a 
doubt  whether  effective  elasticity  is  after  all  assured,  for  it  is 
not  clear  that  the  country  bank  which  needs  money  for  crop- 
moving  purposes  will  have  the  wherewithal  to  get  advances 
from  the  reserve  bank  —  that  is,  that  it  will  have  paper  of  the 
proper  kind  and  in  sufficient  amount  for  rediscount.  How- 
ever, it  seems  probable  that  the  act  as  finally  passed  has  met 
this  need  by  providing  that  agricultural  paper  shall  be  admitted 
on  rather  more  liberal  terms  than  paper  arising  out  of  or- 
dinary commercial  or  manufacturing  business.  If  this  be  so, 
it  would  seem  that  the  provisions  of  the  new  law  for  securing 
one  phase  of  seasonal  elasticity  —  expansibility  —  are  fairly 
adequate. 

Passing,  now,  to  the  other  side  of  elasticity  —  *.  e.,  con- 
tractility—  can  we  say  as  much?  Will  the  new  issues 
promptly  retire  when  their  special  task  is  over  ?  Prima  facie, 
the  verdict  here  is  less  favorable  than  in  the  previous  case. 
In  general,  there  are  two  principal  processes  by  which  a  note 
circulation  may  be  contracted :  ( I )  driving  the  notes  out  of 
circulation,  and  (2)  drawing  them  out.  In  so  far  as  the 
former  process  is  depended  upon,  means  are  devised  to  make 
sure  that  the  notes  shall  persistently  return  to  the  issuer  even 


766         THE  FEDERAL  RESERVE  SYSTEM 

against  his  will  —  they  shall  have  good  homing  power.  By 
the  second  process,  it  is  made  to  the  advantage  of  the  issuer 
of  the  notes  to  hasten  their  withdrawal  himself. 

As  respects  insuring  contractility  by  the  former  of  these 
processes,  the  act  certainly  cannot  claim  to  promise  high 
efficiency.  The  driving-out  process  requires  roughly  the  fulfil- 
ment of  two  conditions :  ( i )  keeping  the  channels  for  the  re- 
turn of  notes  to  the  issuer  fairly  open,  and  (2)  supplying  out- 
siders with  a  motive  for  sending  the  notes  home.  As  regards 
the  former  of  these  conditions,  the  new  system  probably  is 
all  right.  The  return  of  the  notes  to  the  issuer  seems  not  to 
be  impeded  by  the  inconvenience  or  expensiveness  of  the 
process.  All  member  banks  and  all  reserve  banks  must  re- 
ceive these  notes;  and  the  reserve  banks  will  probably  have 
branches  within  easy  reach  of  any  part  of  the  district.  Hence, 
any  holder  desiring  to  get  notes  back  to  the  issuing  bank  will 
find  the  process  easy  and  the  way  open.  But  good  homing 
power  requires  more  than  this.  It  requires,  namely,  that  ade- 
quate motives  be  supplied  to  people  generally,  or,  at  least,  to 
banks  generally,  for  seeing  that  the  notes  get  back.  It  is  not 
enough  that  the  track  be  smooth ;  people  must  desire  to  use  it. 
Now,  earlier  plans  for  securing  elasticity  relied  on  two  prin- 
cipal motives  for  inducing  holders  to  send  notes  back  to  the 
issuer :  ( i )  the  desire  of  such  holders  to  make  room  for  their 
own  notes,  and  ( 2 )  their  desire  to  exchange  money  which  has 
various  limitations  imposed  upon  it  for  money  which  is  free 
from  those  limitations.  It  is  plain  that  the  new  system  makes 
only  a  limited  use  of  the  former  of  these  methods  of  proced- 
ure. Within  the  district  for  which  any  particular  reserve 
bank  is  the  central  bank,  this  particular  force  will  be  practi- 
cally inoperative;  for  the  power  to  issue  notes  on  the  basis  of 
common  assets  is  not  given  to  any  but  the  reserve  banks,  and 
the  profitableness  of  the  power  to  issue  the  old  type  of  note 
has  always  proved  too  low  to  induce  banks  generally  to  take 
much  trouble  to  get  their  own  notes  into  circulation.  As  be- 
tween the  reserve  banks  of  the  different  districts,  however,  this 
particular  motive  will,  of  course,  be  more  or  less  in  evidence, 
since  these  reserve  banks  will  all  be  competitors  for  this  oppor- 
tunity. But  even  here  the  motive  in  question  will  not  play  a 


ELASTICITY  OF  NOTE  ISSUE  767 

large  part,  since  more  effective  means  for  insuring  the  return 
of  the  notes  from  outside  reserve  banks  are  provided  in  other 
parts  of  the  law. 

As  regards  the  second  motive  for  returning  idle  notes — • 
that  is,  the  desire  to  exchange  a  money  subject  to  various  limi- 
tations or  disabilities  for  one  not  subject  to  those  limitations  — 
the  new  act  does  somewhat  better  than  it  does  in  respect  to  the 
first  motive.  It  is,  indeed,  true  that,  within  their  own  district, 
no  special  disability,  like  being  forbidden  to  be  paid  out  by 
other  banks,  is  put  on  the  new  notes.  But  they  are  always 
subject  to  the  disability  of  not  being  legal  reserve  money  in  the 
case  of  federal  banks;  and  hence  such  banks  will  be  more  or 
less  disposed  to  return  the  notes  issued  by  their  own  reserve 
banks,  in  order  to  exchange  them  for  reserve  money.  It  may 
be  doubted,  however,  whether  in  ordinary  times  this  will  prove 
a  very  potent  force,  since  country  banks  will  usually  keep  re- 
serves considerably  in  excess  of  legal  requirements,  and  so  will 
not  need  to  discriminate  nicely  between  the  two  sorts  of  money. 
As  between  different  districts,  the  case  for  the  homing  power 
of  the  new  notes  is  rather  stronger,  since  reserve  banks  are 
prohibited  from  paying  out  the  notes  of  other  reserve  banks 
under  penalty  of  a  10  per  cent.  tax.  Even  here,  however,  the 
provisions  are  none  too  adequate.  While  the  notes  of  a  par- 
ticular reserve  bank  must  not  be  paid  out  by  the  reserve  banks 
of  other  districts,  there  is  no  prohibition  against  their  being 
paid  out  by  the  member  banks  of  other  districts;  and  it  is 
doubtful  whether  there  is  sufficient  motive  to  induce  said  mem- 
ber banks  of  other  districts  to  send  in  these  notes  to  their  own 
reserve  banks  and  so  start  them  on  their  homeward  journey. 
The  desire  to  exchange  money  which  cannot  be  used  as  reserve 
for  that  which  can  be  would  have  some  force ;  but,  under  many 
circumstances,  it  would  probably  prove  rather  inadequate. 

Another  disability  which  contributes  to  the  homing  power 
of  a  bank  note,  and  which  is  actually  used  in  the  case  of  our 
old  note,  is  not  used  with  this  new  note  —  I  mean,  the  fact 
that  they  are  not  receivable  for  customs  dues.  The  decision 
to  omit  this  provision  was  perhaps  wise ;  but  it  throws  out  a 
potent  motive  for  sending  notes  home,  and  thus  throws  away 
an  opportunity  to  make  better  provision  for  their  contractility. 


768  THE  FEDERAL  RESERVE  SYSTEM 

On  the  whole,  then,  it  must  be  acknowledged  that,  in  so  far  as 
homing  power  is  dependent  on  giving  to  outsiders  strong  and 
persistent  motives  for  sending  notes  home,  the  new  law  is  not 
altogether  satisfactory. 

We  have  seen  that  there  is  very  little  in  the  new  system  to 
secure  that  the  notes  shall  have  good  homing  power  —  shall 
get  home  by  what  we  have  called  the  driving-in  process.  Is 
the  system  better  off  as  respects  the  drawing-in  process  ?  Are 
matters  so  arranged  that  the  issuing  bank  will  have  the  power 
and  the  desire  to  withdraw  its  notes  —  or  at  least  contract  the 
currency  proportionately  —  when  the  need  for  the  notes  has 
fallen  off?  As  respects  the  first  part  —  making  sure  that  the 
issuing  bank  shall  have  the  power  to  retire  its  notes,  or  at  any 
rate  to  effect  a  corresponding  contraction  of  the  currency  — 
the  new  system  is  practically  perfect,  as  indeed  was  the  old  one. 
That  is,  any  reserve  bank  desiring  to  contract  its  note  obliga- 
tions may  at  its  discretion  deposit  with  the  federal  reserve 
agent  reserve  notes,  gold,  or  lawful  money.  Obviously,  this, 
if  not  strictly  a  contraction  of  its  note  circulation,  at  least 
brings  about  the  desired  contraction  of  the  general  circulation. 

When,  however,  we  consider  the  provisions  of  the  new  law 
for  insuring  that  reserve  banks  shall  desire  to  contract  their 
circulation  when  the  special  need  has  passed,  we  find  that  the 
law  does  not  promise  quite  so  well.  The  favorite  device  for 
accomplishing  this  result  has  been,  of  course,  a  tax  on  issues, 
similar  to  the  5  per  cent,  tax  of  the  German  system.  Ap- 
parently, the  new  law  provides  for  something  equivalent  to  this 
in  the  shape  of  an  interest  charge  by  the  Federal  Reserve 
Board,  the  rate  to  be  fixed  by  said  board.  How  far  this  device 
will  prove  effective  in  practice  it  is  not  safe  to  predict.  In 
order  that  it  should  induce  the  banks  to  contract  their  circula- 
tion, circumstances  must  have  arisen  under  which  the  issuing 
bank  would  be  earning  on  its  outstanding  notes  a  profit  smaller 
than  the  tax  itself.  Now,  it  does  not  seem  certain  that  an 
excessive  issue  of  notes  would  necessarily  bring  about  this  con- 
dition. In  the  first  place,  in  the  absence  of  good  homing 
power,  a  volume  of  notes  in  excess  of  business  needs  would  not 
necessarily  cause  an  accumulation  of  those  notes  in  the  vaults 
of  the  bank  issuing  them.  Secondly,  so  long  as  member  banks 


ELASTICITY  OF  NOTE  ISSUE  769 

are  free  to  keep  their  balances  in  banking  institutions  other 
than  their  reserve  banks,  an  excess  of  notes  would  not  neces- 
sarily cause  the  general  cash  holdings  of  reserve  banks  to  be 
abnormally  large.  For,  so  long  as  the  ordinary  New  York 
banks  are  permitted  to  pay  interest  on  bankers'  balances,  coun- 
try banks  will  to  a  considerable  extent  keep  their  balances  with 
these  outside  New  York  banks ;  and  it  seems  not  unlikely  that 
the  excessive  monetary  stock  thus  accumulating  in  New  York 
City  would,  instead  of  getting  into  the  hands  of  the  New  York 
reserve  bank,  largely  remain  in  the  hands  of  the  outside  bank- 
ing institutions  and  be  employed  more  or  less  as  it  has  been 
in  the  past,  that  is,  in  financing  doubtful  enterprises  and  sup- 
porting excessive  speculation.  But  if  the  reserve  banks  do 
not  feel  the  pressure  of  excessive  issues  in  the  shape  of  ac- 
cumulations of  notes  or  some  form  of  money  in  their  own 
vaults,  they  may  conceivably  be  able  to  invest  advantageously 
all  the  funds  in  their  possession,  and,  in  that  case,  the  rate  of 
interest  charged  by  the  Federal  Reserve  Board  will  not  furnish 
an  adequate  motive  for  the  retirement  of  their  issues.  Doubt- 
less, however,  this  may  in  some  degree  be  answered  by  saying 
that  even  an  excess  which  was  felt  only  outside  the  reserve 
bank  would,  after  all,  compel  the  reserve  bank  to  contract  its 
issues,  since  it  would  lower  the  rate  of  discount  so  greatly  that 
reserve  banks  could  not  profitably  invest  their  ordinary  hold- 
ings, and  consequently  would  wish  to  get  rid  of  the  interest 
charge.  Perhaps  this  is  true  ;  but  it  would  by  no  means  insure 
the  prompt  and  full  contraction  which  most  reformers  have 
considered  desirable. 

From  the  foregoing  it  would  seem  that  one  of  the  devices 
for  inducing  the  reserve  banks  to  contract  their  issues  after 
the  need  for  them  had  passed  —  that  is,  charging  interest  upon 
such  issues  —  is  not  certain,  at  any  rate,  to  prove  adequate; 
it  will  not  surely  eliminate  the  winter  plethora  in  New  York 
City  which  is  supposed  to  stimulate  and  support  excessive 
stock  speculation.  But  the  new  law  contains  another  pro- 
vision which  may  be  viewed  as  a  device  for  supplying  the  issu- 
ing banks  with  a  motive  for  contracting  their  issues,  namely, 
the  requirement  that  such  banks  shall  keep  a  gold  reserve 
equal  to  40  per  cent,  of  their  issues.  Is  this  likely  to  prove 


770        THE  FEDERAL  RESERVE  SYSTEM 

effective  ?  Probably  not.  Whatever  might  be  true  in  panicky 
times,  it  seems  certain  that  in  an  ordinary  year  the  gold  hold- 
ings of  a  reserve  bank  will  be  much  above  40  per  cent,  of  its 
note  issue.  If  this  be  true,  the  maintenance  of  this  40  per 
cent,  could  become  difficult  only  when  the  excess  of  money 
was  so  great  as  to  cause  a  dangerous  exportation  of  gold  from 
the  country,  and  this  surely  would  show  a  very  inadequate  de- 
gree of  contractility.  In  short,  the  new  law  does  not  insure 
that  issuing  banks  shall  be  sufficiently  disposed  to  draw  in  their 
notes  any  more  than  it  insures  that  outsiders  will  drive  them 
in.  It  would  seem,  then,  that  the  new  law  does  not  promise 
to  give  to  the  note  issue  the  degree  of  contractility  which  has 
hitherto  been  considered  desirable.  In  other  words,  there  is 
some  point  in  the  fear  expressed  by  many  bankers  that  the 
new  law  will  result  in  note  inflation  —  at  least  in  so  far  as 
the  avoiding  of  this  danger  is  dependent  on  the  contractility 
of  the  note  issue.  Very  likely,  however,  the  possibility  of 
such  inflation  is  sufficiently  guarded  against  by  other  pro- 
visions of  the  law. 

We  have  discussed  the  adequacy  of  the  new  note  issue  in 
respect  to  seasonal  or  ordinary  elasticity.  \Ve  pass  on  now 
to  consider  its  adequacy  in  respect  to  emergency  elasticity  — 
the  elasticity  which  enables  a  currency  to  adjust  itself  to  those 
extraordinary  fluctuations  in  need  which  mark  a  banking  panic 
and  the  depression  that  follows.  Broadly  speaking,  it  is  pretty 
certain  that  at  this  point  the  new  law  will  get  a  more  favor- 
able verdict  than  in  the  previous  case.  As  pointed  out  in  an 
earlier  connection,  the  banking  panic,  when  fully  developed, 
gives  rise  to  three  difficulties  and  so  to  three  needs :  ( I )  funds 
to  relieve  the  antecedent  stringency  which  threatens  a  com- 
plete collapse  of  the  credit  structure ;  (2)  a  circulating  medium 
for  ordinary  trade  when  a  general  suspension  of  payment  by 
the  banks  has  brought  on  a  money  famine;  and  (3)  a  prompt 
and  thoroughgoing  contraction  of  the  circulation  in  the  de- 
pression which  follows  the  panic.  Now,  there  surely  can  be 
no  doubt  that,  under  the  new  law,  the  availability  of  an  issue 
sufficient  in  volume  instantly  to  relieve  the  antecedent  strin- 
gency, and  so  to  put  a  stop  to  a  panic  before  it  had  developed 
serious  dimensions,  is  assured.  In  fact,  it  is  not  at  all  im- 


ELASTICITY  OF  NOTE  ISSUE  771 

probable  that,  under  the  new  system,  the  reserve  banks  will  be 
able  to  check  the  development  of  such  a  panic  at  the  very  out- 
set without  increasing  at  all  their  note  issues.  But,  if  this 
does  not  prove  true  —  if  it  turns  out  that  more  currency  is 
needed  for  this  purpose  —  there  would  seem  to  be  no  shadow 
of  doubt  that  the  new  system  will  insure  the  forthcoming  of 
such  currency  both  of  a  quality  and  in  a  quantity  which  will 
be  fully  adequate  to  the  task  put  upon  it.  ( i )  The  notes  to 
be  issued,  being  obligations  of  the  Federal  Treasury,  will  be 
as  acceptable  as  gold  even  on  the  eve  of  a  panic.  (2)  There 
is  no  limit  to  the  absolute  amount  of  these  notes.  (3)  The 
practical  limit  set  by  the  requirement  that  discounted  paper 
shall  be  furnished  as  a  basis  for  their  issue  is  of  no  real  sig- 
nificance, since  such  paper  will  undoubtedly  be  vastly  greater 
in  volume  than  any  need  which  could  arise.  Accordingly, 
there  can  be  no  doubt  that  the  new  system  provides  all  the 
expansibility  needed  to  abort,  or  reduce  to  comparative  harm- 
lessness,  any  panic  which  might  arise. 

A  word  now  with  respect  to  the  second  need  which  an 
emergency  circulation  is  supposed  to  meet,  that  is,  an  ordinary 
circulating  medium  for  trade  when  banks  have  by  common 
consent  suspended  payment.  In  the  first  place,  if  we  are  right 
in  supposing  that  the  new  law  will  surely  prevent  any  panic 
from  reaching  such  a  degree  of  intensity,  it  is  obvious  that  we 
shall  not  have  occasion  to  meet  the  particular  difficulty  here 
under  consideration  —  that  our  note  issue  will  not  be  called  on 
to  display  this  particular  sort  of  elasticity.  If,  however,  it  be 
supposed  that  the  foregoing  prediction  does  not  turn  out  to  be 
correct  —  if  experience  proves  that  panics  can  still  go  so  far 
as  to  cause  banks  generally  to  suspend  payments,  to  hold  on 
to  every  form  of  reasonably  solid  money,  and  to  try  to  satisfy 
the  public  with  substitutes  —  our  verdict  for  the  new  cur- 
rency would  necessarily  be  less  favorable.  We  should  have 
to  admit  that  the  new  law  does  little  or  nothing  to  relieve  such 
a  situation.  Broadly  speaking,  the  new  money  will  be  alto- 
gether too  good  to  meet  this  particular  need.  Banks  that  had 
reached  a  stage  of  panic  sufficiently  intense  to  cause  them  to 
suspend  payment  —  to  hoard  the  ordinary  forms  of  money  — 
would  be  sure  to  hoard  money  as  good  as  those  notes  are 


772         THE  FEDERAL  RESERVE  SYSTEM 

bound  to  be.  That  is,  the  new  issue  would  immediately  pass 
into  hoards,  as  did  the  greenbacks  which  the  Secretary  of  the 
Treasury  reissued  during  the  panic  of  1873,  and»  therefore, 
would  bring  little  if  any  relief  to  the  currency  famine  which 
had  developed.  In  fact,  it  is  almost  impossible  to  conceive 
any  form  of  note  fitted  for  this  particular  task  except  one 
which  was  so  bad  that  there  was  no  danger  of  its  being 
hoarded.  That  is,  the  only  proper  way  to  meet  this  particular 
need  of  a  severe  panic  is  to  make  sure  that  it  does  not  arise 
at  all ;  and,  in  this  respect,  the  new  law  promises  well. 

We  come,  finally,  to  the  third  need  which  emergency  elas- 
ticity is  supposed  to  meet,  that  is,  a  prompt. and  great  contrac- 
tion of  the  circulation  when  the  panic  has  passed  and  the 
inevitable  business  depression  consequent  upon  such  a  panic 
has  set  in.  Here,  again,  though  not  in  the  same  degree  as  in 
the  last  case,  if  the  new  law  proves  as  successful  as  many  con- 
servative students  expect,  the  need  in  question  will  be  little,  if 
at  all,  experienced.  We  shall  usually  escape  the  extreme  busi- 
ness inflation  of  the  antepanic  period ;  the  panic  itself  will  be 
much  abated,  if  not  completely  eliminated;  and,  in  conse- 
quence, the  trade  reaction  which  naturally  follows  a  panic 
will  be  much  diminished  in  intensity.  If  this  turns  out  to  be 
true,  the  circulation  will  never  again  show  such  an  extraor- 
dinary glut  as  characterized  the  winter  of  1893-94.  Never- 
theless, it  can  hardly  be  doubted  that,  after  even  an  incipient 
panic,  there  will  be  some  reaction,  and  consequently  a  more  or 
less  plethoric  condition  of  the  currency  will  follow.  Will  the 
new  issue  have  sufficient  contractility  to  meet  this  need? 
Earlier  in  this  paper  we  have  seen  that  the  conditions  attached 
to  the  new  issue  are  in  general  not  favorable  to  contractility, 
in  that  they  do  not  provide  for  either  the  prompt  driving  home 
or  the  prompt  drawing  home  of  the  notes  when  the  necessity 
for  their  issue  is  past.  Outsiders  lack  adequate  motives  for 
sending  the  notes  home ;  issuers  lack  adequate  motives  for  call- 
ing them  home.  The  case  for  emergency  contractility,  how- 
ever, is  somewhat  better  than  the  case  for  ordinary  con- 
tractility. First,  it  is  probable  that  the  homing  power  of  the 
note  will  prove  greater  at  such  a  time  than  in  an  ordinary 
year,  for,  at  such  a  time,  outside  banks  will  not  be  able  to  find 


NOTES  PRINTED  AND  ISSUED  773 

investments  for  their  funds,  since  speculative  trading  will  dis- 
appear altogether  and  business  generally  will  be  at  a  very  low 
ebb.  Again,  it  seems  certain  that  the  issuing  bank  will,  in  this 
case,  have  more  than  the  usual  motive  for  bringing  about  a 
contraction  of  the  circulation.  The  chief  reason  why  such  a 
bank  may  not  be  eager  in  ordinary  times  to  hasten  the  retire- 
ment of  its  notes  is  the  fact  that,  provided  the  notes  do  not 
accumulate  in  its  own  vaults,  such  a  bank  will  gain  more  by 
using  the  funds  in  its  possession  to  make  loans  than  it  would 
by  using  them  to  retire  notes,  assuming  that  the  interest  charge 
made  by  the  Federal  Reserve  Board  is  not  placed  excessively 
high.  But  it  is  practically  certain  that,  in  the  depression  which 
follows  a  panic,  no  reserve  bank  will  have  opportunities  for 
keeping  all  of  its  funds  busy;  and  since,  in  that  case,  the  in- 
terest charge,  however  small,  will  be  a  dead  loss,  the  bank  will 
have  adequate  motive  for  effecting,  as  promptly  as  possible, 
an  adequate  contraction  of  its  note  liabilities.  This  motive 
would  be  still  further  strengthened  should  the  glut  prove  suffi- 
cient to  cause  a  decided  drain  of  gold,  since,  in  that  case,  the 
reserve  banks  will  find  difficulty  in  maintaining  the  required 
40  per  cent,  reserve.  On  the  whole,  then,  we  seem  warranted 
in  affirming  that,  as  respects  emergency  elasticity,  the  new 
notes  will  give  no  serious  disappointment. 

Finally,  as  respects  elasticity  in  general,  though  the  note 
issue,  viewed  by  itself,  does  not  seem  quite  fitted  to  satisfy  the 
tests  which  an  old-fashioned  advocate  of  elasticity  is  inclined 
to  impose  upon  it,  yet,  when  we  take  the  new  law  as  a  whole, 
it  seems  not  unreasonable  to  affirm  that  it  promises  to  accom- 
plish, directly  or  indirectly,  most  of  the  ends  which  we  had 
hoped  to  attain  through  elasticity  and  hence  promises  to  give 
us  a  system  which  in  essentials  is  truly  and  adequately  elastic. 

NOTES  PRINTED  AND  ISSUED 

1  During  the  year  1915  the  circulation  of  Federal  Reserve 
notes  has  increased  to  $188,817,000  as  of  December  31,  1915. 
Believing  that  the  country  should  be  prepared  against  any  con- 
tingency, the  Board  had  authorized  the  printing  of  about  $700,- 

i  Second  Annual  Report  of  the  Federal  Reserve  Board,  p.  16.     1916. 


774        THE  FEDERAL  RESERVE  SYSTEM 

000,000  of  these  notes.  "  Almost  one-quarter  of  the  total  sup- 
ply printed  has  been  placed  in  circulation.  On  December  31, 
1915,  however,  only  $16,675,000  of  notes  secured  by  com- 
mercial paper  pledged  with  the  Federal  Reserve  Agents  was 
outstanding  as  an  obligation  of  the  Federal  Reserve  Banks. 
The  liability  of  the  Federal  Reserve  Banks  as  to  the  remainder 
has  been  discharged  by  the  deposit  with  the  Federal  Reserve 
Agents  of  a  like  amount  of  gold  and  lawful  money.  This  re- 
sult has  been  achieved  by  the  Federal  Reserve  Banks  in  re- 
sponding to  requirements  for  currency  by  issuing  Federal 
Reserve  notes  rather  than  by  parting  with  gold.  While  the 
gold  pledged  with  the  Federal  Reserve  Agents  represents  a 
very  valuable  protection  in  case  of  a  substantial  demand  for 
gold,  it  must  be  observed  that  the  process  is  expensive  without, 
at  the  same  time,  giving  to  the  Federal  Reserve  Banks  that 
additional  strength  and  lending  power  which  they  would  secure 
in  case  the  law  were  amended  so  that  the  Federal  Reserve 
Banks  would  remain  liable  for  the  outstanding  notes,  but,  on 
the  other  hand,  would  retain  property  title  to  the  gold  delivered 
to  the  federal  reserve  agents,  which,  in  that  case,  would  not  be 
paid  in  to  extinguish  the  liability  upon  the  notes  but  would  be 
deposited  as  collateral  security  against  them. 

IMPOUNDING  GOLD 

1  On  November  16,  1914,  the  first  shipment  of  Federal  Re- 
serve notes  was  received  by  the  Federal  Reserve  Agent  [of 
the  Federal  Reserve  Bank  of  New  York]  from  the  Comp- 
troller of  the  Currency.  On  November  19  the  bank  pledged 
with  the  Federal  Reserve  Agent  $500,000  of  commercial 
paper  rediscounted  by  member  banks  and  received  from  him 
a  similar  amount  of  Federal  Reserve  Notes.  These  notes 
were  not  required  by  the  banks  which  made  the  rediscounts, 
as  they  had  already  withdrawn  by  checks  the  credits  so  estab- 
lished. They  were  taken  by  this  bank  for  its  general  use. 
The  issue  of  Federal  Reserve  notes  gave  the  reserve  bank  the 
opportunity  of  affording  to  its  member  banks  complete  inter- 

1  First  Annual  Report  of  the  Federal  Reserve  Bank  of  New  York,  pp. 
19,  20.    1916. 


IMPOUNDING  GOLD  775 

changeability  between  book  and  note  credits.  The  bank  there- 
fore established  the  policy  of  issuing  Federal  Reserve  notes 
freely  to  any  member  bank  desiring  them  whether  the  credit 
thus  withdrawn  was  established  by  it  through  rediscounting, 
or  the  deposit  of  checks,  or  the  deposit  of  gold  or  lawful 
money.  In  practice,  however,  most  credits  withdrawn  by 
notes  have  been  established  by  the  deposit  of  checks  which 
have  been  collected  by  this  bank  in  gold  or  lawful  money 
through  the  clearing  house.  Accordingly,  the  accumulation 
of  cover  in  the  hands  of  the  Federal  Reserve  Agent  has  been 
mainly  gold,  with  but  a  small  amount  of  rediscounts.  The 
processes  provided  by  the  act  for  the  issue  of  Federal  Reserve 
notes  to  the  reserve  bank  permit  complete  interchangeability 
between  gold  and  rediscounts  held  by  the  agent.  Gold  may  be 
substituted  for  rediscounts  and  rediscounts  for  gold,  in  accord- 
ance with  the  requirements  of  the  reserve  bank.  During  the 
entire  period  its  requirements  have  been  for  notes  with  which 
it  might  exercise  its  statutory  right  to  "  exchange  federal  re- 
serve notes  for  gold,  gold  coin,  or  gold  certificates." 

The  policy  of  the  Federal  Reserve  Bank  has  resulted  in 
greatly  strengthening  its  gold  position  and  its  ability  to  assist 
its  member  banks  or  other  Federal  Reserve  Banks  should  they 
at  any  future  time  seek  credit  in  order  to  withdraw  gold  for 
domestic  or  foreign  uses.  Through  this  policy  also  it  has  been 
able  potentially,  at  least,  to  retard  the  expansion  of  credit  by 
impounding  in  the  hands  of  the  agent  a  large  volume  of  gold 
which  might  otherwise  have  found  its  way  into  bank  reserves 
already  superabundant. 

Furtherfore,  through  this  policy  it  has  been  able  to  take  the 
first  step  toward  accomplishing  one  of  the  purposes  of  the  act 
set  forth  in  its  title,  e.  g.,  "  to  furnish  an  elastic  currency." 
There  are  two  forms  of  elasticity,  one  of  quantity  and  the 
other  of  quality,  both  provided  for  in  the  act. 

From  the  point  of  view  of  cover,  the  gold  certificate  is  com- 
pletely inelastic.  It  stands  at  one  extreme  of  our  currency, 
with  a  dollar  of  gold  set  aside  behind  each  dollar  of  paper. 
At  the  other  extreme  stands  the  national-bank  note,  with  only 
5  cents  of  gold  set  aside  behind  each  dollar  of  paper.  The 
assets  of  the  issuing  bank  make  it  good,  but  its  elasticity  is 


776         THE  FEDERAL  RESERVE  SYSTEM 

nullified  by  the  requirement  that  it  must  be  secured  dollar  for 
dollar  by  government  bonds. 

Between  these  two  extremes  the  Federal  Reserve  note,  a  new 
form  of  currency,  has  been  introduced.  For  each  dollar  of 
this  paper  there  is  set  aside  from  40  cents  to  $i  of  gold.  As  in 
the  case  of  the  national-bank  note,  the  obligation  of  the  United 
States  and  the  assets  of  the  issuing  bank  secure  it. 

The  process  in  which  this  and  other  Federal  Reserve  Banks 
have  been  engaged  is  the  substitution,  as  a  circulating  medium, 
of  a  note  which  is  elastic  in  quality  for  the  inelastic  gold  cer- 
tificate. Gold  is  the  most  uneconomical  medium  of  hand-to- 
hand  circulation  since,  when  held  in  bank  reserves,  it  will 
support  a  volume  of  credit  equal  to  four  or  five  times  its  own 
volume.  What  the  reserve  bank  does  in  accumulating  gold 
behind  its  Federal  Reserve  notes  is  to  establish  with  the  holder 
of  each  note  a  credit  which  may  be  availed  of  whenever  the 
occasion  requires.  With  this  credit  established  it  can  convert 
at  \vill  its  gold-covered  notes  into  notes  covered  partly  by  gold 
and  partly  by  commercial  paper.  In  times  when  credit  is  be- 
coming strained  and  bank  reserves  need  strengthening  or  when 
gold  must  be  exported,  this  conversion  will  take  place,  and 
after  the  strain  is  over  the  gold  cover  will  be  restored  through 
the  repayment  of  the  rediscounts  substituted  for  it.  In  this 
way  elasticity  of  quality  in  our  currency  is  obtainable.  But 
it  should  not  be  construed  as  in  any  way  a  deterioration  of  the 
currency  contemplated  by  the  act.  Quite  the  reverse  is  true. 
The  act  provides  for  the  issue  of  Federal  Reserve  notes  in  un- 
limited amounts,  with  40  cents  of  gold  behind  each  dollar  of 
paper.  This  is  elasticity  of  quantity  and  it  becomes  operative 
with  the  minimum  of  gold  cover.  Elasticity  of  quality,  on 
the  other  hand,  operates  with  a  gold  cover  always  above  the 
40  per  cent,  minimum  and  ranging  as  high  as  100  per  cent. 

In  order  to  be  prepared  for  any  currency  demands  which 
might  be  made  upon  it,  the  Federal  Reserve  Bank  of  New  York 
in  the  spring  of  1915  adopted  the  policy  of  having  printed  and 
keeping  constantly  on  hand  a  supply  of  Federal  Reserve  notes 
substantially  in  excess  of  the  amount  of  emergency  currency 
which,  experience  shows,  this  district  might  be  called  upon  to 
supply.  The  maintenance  of  this  policy  and  of  the  policy  of 


FINANCIAL  POLICY  OF  BANKS  777 

issuing  Federal  Reserve  notes  freely  has  entailed  a  heavy  cost 
upon  this  bank.  Unissued  Federal  Reserve  notes  are  carried 
at  cost  on  the  books  of  the  bank,  and  at  the  end  of  each  month 
the  amount  of  notes  issued  to  the  bank  during  the  month  is 
charged  off  at  cost.  The  shipment  of  notes  unfit  for  circula- 
tion to  the  Comptroller  of  the  Currency  at  Washington  for 
cancellation  and  destruction  is  a  further  item  of  expense  in 
connection  with  the  maintenance  of  these  policies.  The  di- 
rectors and  officers  of  the  bank,  however,  feel  that  the  results 
accomplished  amply  justify  the  expense  incurred,  and  consider 
that  the  added  strength  furnished  the  bank  by  the  gold  thus 
accumulated  is  perhaps  the  most  important  result  of  the  opera- 
tions of  the  period. 

Some  reduction  has  already  been  made  in  the  cost  of  print- 
ing Federal  Reserve  notes,  and  it  is  to  be  hoped  that  further 
experience  and  study  will  enable  other  substantial  reductions 
to  be  made  in  the  cost  of  preparing  for  issue  what  has  already 
become  an  important  element  of  the  circulating  medium  of  the 
country.  The  act  provides  that  all  expenses  in  connection 
with  the  issue  and  redemption  of  Federal  Reserve  notes  shall 
be  borne  by  the  Federal  Reserve  Banks,  and  in  view  of  the 
service  the  banks  are  performing  in  accumulating  gold  through 
the  medium  of  these  notes,  the  feeling  is  quite  general  among 
their  officers  that  the  notes  should  be  furnished  to  them  at  the 
lowest  possible  cost  consistent  with  the  high  quality  of  work- 
manship required. 

The  design  of  the  notes  is  not  altogether  satisfactory  for 
efficient  handling.  In  sorting  notes  it  is  necessary  to  be  able 
readily  to  distinguish  between  notes  of  this  bank  and  notes  of 
other  reserve  banks.  This  would  be  greatly  facilitated  if  the 
printing  of  the  distinctive  number  and  letter  of  each  bank  were 
made  more  general  on  the  face  of  the  note. 

THE  FINANCIAL  POLICY  OF  THE  FEDERAL  RESERVE 
BANKS 1 

It  seems  clear  that  the  cardinal  principle  in  the  management 

1  Thomas  Conway,  Jr.,  The  Financial  Policy  of  the  Federal  Reserve 
Banks,  The  Journal  of  Political  Economy,  Vol.  22,  No.  4,  April,  1914,  pp. 
319-331. 


7/8         THE  FEDERAL  RESERVE  SYSTEM 

of  the  Federal  Reserve  Banks  will  be  to  disregard  the  course 
which  will  lead  to  maximum  profits,  following  instead  the 
path  which  will  lead  to  the  greatest  safety  and  which  will 
permit  these  banks  to  be  of  the  greatest  service  to  the  nation. 
Large  reserves  should  be  maintained,  and  these  should  consist 
chiefly  of  gold.  The  payment  of  interest  upon  bankers'  de- 
posits and  government  deposits  should  be  avoided,  if  possible, 
for  the  reason  that  the  payment  of  interest  will  force  the 
keeping  of  smaller  reserves,  if  the  cumulative  dividend  is  to 
be  earned.  The  banks  should  be  managed,  not  from  the 
standpoint  of  profit,  but  from  the  standpoint  of  safety. 

Yet  this  is  but  one  side  of  the  policy  of  the  Federal  Reserve 
Banks.  Their  power  and  influence  can  be  made  to  extend 
much  farther  than  would  result  solely  from  the  wise  manage- 
ment of  their  own  affairs.  These  banks  are  the. financial  trus- 
tees of  the  nation.  The  country  will  look  to  them  to  see  that 
they  exercise  over  the  member  banks  a  closer  supervision  and 
discipline  than  has  been  possible  in  the  past.  Supplementing 
a  negative  control  by  the  bank  examiners,  who  are  powerless 
so  long  as  the  letter  of  the  law  is  observed,  the  federal  reserve 
banks  will  be  a  great  positive  force.  The  Federal  Reserve 
Banks,  with  the  approval  of  the  Federal  Reserve  Agent  or  the 
Federal  Reserve  Board,  may  conduct  examinations  of  a  mem- 
ber bank,  both  for  the  purpose  of  ascertaining  its  condition, 
and,  what  will  be  of  equal  importance,  for  the  purpose  of  de- 
termining the  lines  of  credit  which  are  being  extended  by  it. 

In  the  long  run,  the  greatest  work  which  the  Federal  Reserve 
Banks  can  do  for  the  business  men  of  this  country  is  to  im- 
prove and  standardize  the  methods  of  commercial  borrowing. 
I  believe  it  is  possible  for  these  banks,  with  the  approval  of 
the  Federal  Reserve  Board,  under  the  power  just  quoted,  to 
establish  a  comprehensive  credit  information  clearing  service 
through  which  the  aggregate  loans  of  all  large  borrowers  can 
be  known  by  any  bank  official  and  through  which  excessive 
borrowing  or  the  lending  of  money  to  concerns  pursuing  un- 
wise financial  policies  can  be  checked  before  disaster  overtakes 
them.  This  is  one  of  the  greatest  needs  of  our  banking  sys- 
tem. 


RELATIONS  WITH  MEMBERS  779 


RELATIONS  OF  FEDERAL  RESERVE  BANKS  WITH  MEMBER 

BANKS 1 

The  aim  of  this  bank  [Federal  Reserve  Bank  of  New  York] 
at  all  times  has  been  to  maintain  frank  and  friendly  relations 
with  its  member  banks.  At  every  meeting  of  the  New  York 
or  New  Jersey  Bankers'  Associations,  or  of  their  groups,  to 
which  invitations  have  been  received,  one  or  more  of  the 
directors  or  officers  have  been  present  and  discussed  the  de- 
velopment of  the  various  functions  of  the  system. 

When  the  establishment  of  an  intradistrict  collection  system 
was  under  consideration,  the  directors  and  officers  invited  rep- 
resentative member  bankers  from  all  parts  of  the  district  to 
confer  with  them  at  the  office  of  the  bank.  The  plan  finally 
adopted  was  thoroughly  discussed  in  all  its  aspects  and  a  con- 
sensus of  opinion  seemed  to  prevail  that  it  was  a  fair  and 
reasonable  plan. 

When  the  conditions  under  which  State  banks  should  be 
admitted  to  the  reserve  system  were  under  consideration  three 
conferences  were  held  by  the  directors  and  officers  of  the  bank, 
one  with  national  bankers,  one  with  State  bankers,  and  one 
with  trust  company  officers,  from  various  parts  of  the  district, 
to  ascertain  their  views  upon  the  question  at  issue.  In  every 
case  the  policy  has  been  pursued  of  dealing  frankly  with  those 
present,  in  order  that  they  might  understand  fully  how  the 
action  under  consideration  would  affect  them. 

The  officers  have  expressed  themselves  at  all  times  as  desir- 
ous of  establishing  personal  relations  with  officers  of  member 
banks  and  have  invited  them  to  call  at  the  bank  when  in  New 
York  City.  Yet  a  year  has  gone  by  and  officers  of  probably 
not  over  15  per  cent,  of  the  member  banks  have  done  so. 
Many  of  them  still  have  the  feeling  that  the  bank  is  a  branch 
of  the  Government.  Their  experience  with  the  Government 
consists  principally  of  the  statutory  and  supervisory  relation- 
ship which  exists  between  them  and  the  Comptroller's  office. 
The  conception  of  the  relation  of  this  institution  with  them  as 

1  First  Annual  Report  of  the  Federal  Reserve  Bank  of  New  York,  pp. 
34-36.    1916. 


780         THE  FEDERAL  RESERVE  SYSTEM 

co-operative  makes  headway  slowly.  The  fact  that  the  na- 
tional banks  were  practically  compelled  to  join  the  system 
naturally  retards  the  development  of  the  co-operative  idea. 
The  change  of  attitude,  upon  which  the  success  of  the  system 
will  ultimately  depend,  will  probably  come  slowly,  but  there 
are  already  signs,  as  we  enter  upon  the  second  year  of  the 
system,  that  the  banks  are  getting  more  accustomed  to  it  and 
appreciate  the  results  it  has  already  accomplished.  It  is  hoped 
that  during  the  coming  year,  with  organization  pressure  some- 
what lessened,  more  time  can  be  devoted  by  the  officers  to  de- 
veloping personal  relations  with  the  officers  of  member  banks. 

The  present  attitude  of  the  member  banks  toward  the  re- 
serve bank  may  be  summarized  as  follows : 

The  New  York  City  banks,  upon  which  the  strain  of  all 
crises  first  and  chiefly  falls,  fully  understand  the  value  and 
benefits  of  the  system.  While  regretting  the  loss  of  bank  de- 
posits which  will  probably  be  drawn  from  them  (estimated  to 
be  as  high  as  $250,000,000),  they  are  nevertheless  hearty  sup- 
porters of  the  system,  at  all  times  co-operative  in  their  attitude. 

Many  of  the  banks  in  other  large  cities  are  unable  to  take 
full  advantage  of  the  lowered  reserve  requirements,  but  in 
spite  of  the  loss  of  interest  on  their  reserve  balance,  most  of 
them  understand  what  the  system  in  its  larger  aspects  means 
for  American  banking  and  generally  give  it  their  support. 

While  the  same  may  be  said  of  many  of  the  country  banks, 
yet  it  is  among  the  country  banks  as  a  class  that  most  of  the 
apathy  and  hostility  to  the  federal  reserve  system  which  still 
persists  is  found.  Their  opportunities  and  earnings  are  rela- 
tively small,  and  in  order  to  live  they  must  figure  closely. 
They  feel  the  loss  of  interest  on  reserve  deposits;  the  absence, 
as  yet,  of  dividends  on  their  capital  contribution;  and  the 
prospective  loss  or  decrease  of  the  exchange  they  generally 
charge  on  remitting  for  checks  drawn  upon  them.  Many 
banks  in  industrial  centres  are  precluded  by  the  activity  of 
their  business  from  taking  advantage  of  the  reduction  in  the 
required  reserve.  They  believe  that  they  will,  in  fact,  be  re- 
quired to  carry  an  even  larger  reserve  than  heretofore  in  order 
to  obtain  collection  service  for  notes,  drafts,  and  nonmember 
bank  checks  and  the  various  other  services  now  rendered  by 


RELATIONS  WITH  MEMBERS  781 

their  reserve  agents,  but  not  yet  undertaken,  by  the  reserve 
banks.  It  is  very  natural  that  they  should  view  with  reluct- 
ance the  termination  or  diminution  of  long-standing  business 
associations  with  their  reserve  agents.  Few  of  them,  as  yet, 
conceive  of  the  reserve  bank  as  their  active  reserve  agent,  per- 
forming all  the  services  which  go  with  the  relationship.  The 
dormant  accounts  most  of  the  banks  maintain  with  the  reserve 
bank  are,  perhaps,  indicative  of  their  attitude  toward  it.  Rela- 
tively few  banks  of  this  district  are  borrowers;  in  good  times 
and  bad  they  have  been  able  when  necessary  to  borrow  from 
their  city  correspondents  on  bonds  or  on  the  indorsement  of 
their  directors,  two  avenues  which  are  now  to  be  closed  to 
them.  The  rediscounting  privilege  has  been  little  availed  of 
and  the  larger  functions  of  the  Federal  Reserve  System,  such 
as  influencing  domestic  rates  and  international  gold  movements 
through  the  development  of  a  discount  market  and  by  dealing 
in  foreign  bills,  appear  remote  from  their  spheres  of  activity. 
They  feel  that  the  system  has  few  advantages  to  offer  in  return 
for  the  cost  it  entails  upon  them. 

All  of  these  points  will  be  felt  with  increasing  acuteness 
by  the  country  banker  as  his  reserve  transfers  approach  com- 
pletion and  as  reduced  balances  result  in  reduced  service  from 
his  city  correspondent.  His  point  of  view  is  outlined  thus 
frankly  in  order  that  the  difficulties  he  sees  may  be  clearly 
recognized  and  steps  taken  gradually  to  remove  them.  The 
development  of  a  more  satisfied  relationship  requires  progress 
on  the  part  of  the  reserve  bank  and  a  willingness  to  co-operate 
on  the  part  of  the  country  banker. 

The  reserve  bank  should  organize  a  complete  collection  sys- 
tem embracing  the  handling  of  notes,  drafts,  and  items  on  non- 
member  banks,  which  eventually  will  bring  all  the  members 
into  daily  active  relations  with  the  bank.  It  must  be  ready  to 
act  for  member  banks  in  the  purchase,  sale,  and  custody  of 
securities;  to  supply  credit  information  on  names  whose  paper 
is  offered  by  brokers;  to  give  its  members  information  con- 
cerning methods  of  developing  the  new  functions  which  the 
act  authorizes  them  to  exercise;  to  perform  the  services  now 
rendered  by  their  reserve  agents ;  and  generally  to  assist  them 
in  every  reasonable  way. 


782         THE  FEDERAL  RESERVE  SYSTEM 

The  member  banks  should  look  upon  the  reserve  bank  not 
1  as  an  alien  but  as  their  own  institution.  They  own  all  its 
capital  and  most  of  its  resources,  and  they  control  its  manage- 
ment through  the  directors  they  elect,  subject  always  to  the 
supervision  of  the  Reserve  Board.  At  the  reserve  bank  they 
may  borrow  as  a  standing  right  and  not  as  a  favor  which 
may  be  cut  off.  They  no  longer  have  to  buy  or  carry  bonds 
to  serve  as  security  for  loans;  the  paper  of  their  own  custom- 
ers, large  or  small,  will  now  serve  as  their  security.  While 
panics  in  the  past  may  not  have  affected  them,  they  have  been 
disastrous  to  the  business  interests  of  the  country,  who  are 
their  customers;  and  their  contributions  to  the  reserve  bank 
should  be  recognized  as  a  form  of  insurance  not  merely  for 
themselves  but  for  their  customers  as  well.  If  this  insurance 
is  expensive  and  makes  some  changes  in  the  nature  of  their 
business,  the  act  should  be  carefully  studied  with  a  view  to 
making  the  most  of  the  new  functions  it  provides.  New  ave- 
nues of  activity  should  be  looked  for.  The  banks  which  will 
get  the  most  out  of  membership  are  those  which  are  the  first 
to  see  and  develop  the  opportunities  it  provides  and  to  educate 
their  customers  to  the  protection  and  facilities  they  will  enjoy 
through  the  system.  The  occasion  is  a  favorable  one  also 
for  the  correction  of  abuses.  Customers  will  do  things  in 
the  name  of  the  Federal  Reserve  System  which  they  have  never 
done  before.  The  experience  of  banks  in  using  the  forms 
provided  by  the  reserve  bank  to  get  statements  from  their 
borrowers  is  evidence  of  this.  The  occasion  should  be  seized 
also  to  increase  the  balances  of  depositors  who  carry  unprofit- 
able accounts.  To  assist  member  banks  in  studying  their  ac- 
counts this  bank  has  had  under  preparation  by  chartered  public 
accountants  a  reasonably  simple  form  for  analyzing  accounts 
which  may  be  obtained  by  banks  desiring  to  use  it. 

It  is  the  duty  of  the  directors  and  officers  to  understand  not 
only  the  problems  of  the  reserve  bank  but  those  of  the  member 
banks  as  well ;  and  it  has  been  their  endeavor  during  the  past 
year  to  give  special  study  to  those  of  the  country  bank.  Sev- 
eral suggestions  for  the  relief  of  the  country  bank  have  come 
to  their  notice. 

One  of  these,  which  the  American  Bankers'  Association  at 


RELATIONS  WITH  MEMBERS  783 

its  1915  Seattle  convention  favored,  was  to  permit  the  3  per 
cent,  of  reserve  which  the  member  bank  may  carry  either  in  its 
vaults  or  in  the  reserve  bank,  to  be  deposited  with  member 
banks  not  more  than  300  miles  distant  and  count  as  reserve. 
This  seems  to  be  contrary  to  the  spirit  and  intent  of  the  act, 
which  is  primarily  to  centralize  reserves  in  Federal  Reserve 
Banks. 

Another  suggestion  which  seems  more  worthy  of  considera- 
tion is  that  the  percentage  of  reserve  required  for  country 
banks  should  be  somewhat  further  reduced.  When  the  re- 
serve transfers  are  completed  checks  in  transit  can  no  longer 
count  as  reserves.  It  is  clear,  therefore,  that  the  reserve  re- 
duction contemplated  by  the  act  will  not  be  realized  in  practice. 
A  further  reduction  in  the  reserve  requirements  would,  in  the 
case  of  many  banks,  result  in  a  reserve  less  than  the  amount 
their  business  actually  required,  and  would  enable  them  to 
carry  the  amount  thus  freed  wherever  it  would  best  serve  their 
particular  business,  and,  if  they  so  desired,  to  maintain  some 
relations  with  present  city  correspondents.  It  would  lead 
away  from  the  present  rigidity  of  bank  reserves  toward  greater 
flexibility  and  a  better  understanding  of  their  meaning  and 
purpose. 

RELATIONS  BETWEEN  THE  FEDERAL  RESERVE  BANK  OF  MINNE- 
APOLIS   AND    ITS    MEMBERS 

1  The  Ninth  Federal  Reserve  Bank  has  sought  to  make  the 
Federal  Reserve  Act  fully  operative  within  its  district.  Dur- 
ing the  spring  of  1915  it  had  opportunity  to  demonstrate  its 
effectiveness  in  meeting  the  requirements  of  agriculture  in  the 
Northwest  during  the  planting  season,  and  rediscounted  liber- 
ally for  member  banks,  in  order  to  enable  them  to  better 
satisfy  the  requirements  of  farmers.  It  relieved  local  pressure 
at  a  number  of  points  where  manufacturing  enterprises  and 
general  business  were  depressed  because  of  war  conditions, 
and  had  opportunity  to  show  that  it  can  efficiently  meet  the 
demands  of  industry.  Again,  in  the  fall  of  the  year,  when 
an  adverse  season  had  created  large  amounts  of  immature 

1  Second  Annual  Report  of  the  Federal  Reserve  Board,  pp.  313,  314. 
1916. 


784         THE  FEDERAL  RESERVE  SYSTEM 

corn,  it  was  able  to  perform  a  very  valuable  service  in  assisting 
member  banks  to  meet  the  requirements  of  farmers  who  were 
suddenly  compelled  to  make  provision  for  utilizing  a  valuable 
forage  crop.  During  the  prevalence  of  the  foot-and-mouth 
disease  it  was  able  to  come  to  the  assistance  of  many  banks  in 
the  western  part  of  its  territory,  which  had  applications  for 
loans  from  numerous  stockmen  who  had  cattle  ready  for  mar- 
ket, but  were  unable  to  ship  on  account  of  quarantine  condi- 
tions. The  service  above  indicated,  while  not  perhaps  of 
notable  consequence  in  any  single  case,  consists  in  the  aggre- 
gate of  a  very  valuable  degree  of  assistance,  which  would  not 
have  been  available  except  for  the  Federal  Reserve  Bank,  and 
without  which,  portions  of  the  district  would  have  encountered 
considerable  hardships. 

RELATIONS  BETWEEN  THE  FEDERAL  RESERVE  BANK  OF  BOSTON 
AND   ITS    MEMBER   BANKS 

1  Owing  to  the  unusual  conditions  existing  in  the  money 
market,  and  to  the  fact  that  the  reserve  city  banks  offer  facil- 
ities to  the  country  banks  which  this  bank  has  not  yet  devel- 
oped, more  particularly  in  connection  with  the  collection  of 
checks  and  other  items,  the  latter  banks  have  carried  only  their 
minimum  reserve  requirements  with  this  bank  and  have  used 
its  facilities  only  to  a  limited  extent.  The  relations  between 
country  bank  officials  and  the  officials  of  this  bank  have  been 
most  cordial.  While  many  of  the  banks  in  this  district  are 
borrowing,  most  of  them  find  it  much  more  convenient  to  go 
to  their  correspondent  bank  and  borrow,  either  in  the  form 
of  a  demand  loan,  with  or  without  collateral,  or  against  a 
certificate  of  deposit. 

The  Comptroller's  calls  on  the  several  dates  show  the  total 
borrowings  of  member  banks  in  the  district  as  compared  with 
their  rediscounts  with  this  bank,  as  follows : 

1  Ibid.,  pp.  134-6. 


RELATIONS  WITH  MEMBERS 


785 


Total 
borrowed. 

Borrowed, 
F.  R.  B. 

Dec.   31.   IQI4,   . 

$4.7-18416 

$105  ooo 

Mar.  4,  1915  

A  047  7o8 

234  ^31 

Mav  I    lOi1?  . 

-J  060  7QO 

4.IO  72"* 

June  23.  lOiS  . 

A.  <?84  /MS 

27O  44.1 

Sept.  2,  1915   

3  308  8^6 

190849 

Nov.  10    1915   

2  08^  4.06 

I  -i  T  72£ 

The  officials  of  the  city  banks  on  the  other  hand  are  ap- 
parently satisfied  with  the  progress  made  in  the  development 
of  this  bank's  functions.  While  but  few  of  the  Boston  banks 
have  rediscounted  with  us,  almost  all  have  intimated  that 
should  occasion  arise  they  would  do  so.  Furthermore,  sev- 
eral Boston  banks  have  entered  into  the  acceptance  business  to 
a  large  extent,  and  the  assistance  that  this  bank  has  given  in 
the  matter  of  rates  and  market  for  acceptances  has  done  much 
to  bring  it  into  favor  with  those  banks.  The  Boston  banks 
have  also  used  this  bank  to  a  large  extent  in  exchange  transac- 
tions, and  the  services  offered  by  the  gold  settlement  fund  have 
been  used  almost  exclusively  by  those  banks. 

Thus  far  Boston  banks  have  received  more  benefits  from 
this  bank  than  have  the  other  banks  in  this  district.  A  pos- 
sible exception  to  this  is  in  Aroostook  County,  Me.,  where, 
owing  to  an  unusual  situation  surrounding  the  principal  in- 
dustry, the  potato  crop,  banks  have  relied  on  this  bank  to  a 
considerable  extent  to  carry  them  through  a  trying  period. 
The  moral  effect  of  having  the  Federal  Reserve  Bank  of  Bos- 
ton stand  behind  them  was  not  only  appreciated  by  those  banks, 
but  enabled  them  to  handle  their  business  much  more  satis- 
factorily and  to  finance  themselves  without  having  to  call  upon 
this  bank  to  an  undue  extent  for  rediscounts  or  without  em- 
barrassing their  customers. 

FEDERAL  RESERVE  BANKS  AND  THE  ACCEPTANCE  MARKET 

1  The  right  to  accept  drafts  was  conferred  on  New  York 
State  banking  institutions  by  the  act  of  April  16,  1914. 
Shortly  afterwards  a  few  acceptances  were  reported,  princi- 
pally against  securities.  It  was  not  until  the  derangement  of 

i  Ibid.,  pp.  23-25. 


786 


THE  FEDERAL  RESERVE  SYSTEM 


international  credit  facilities  at  the  opening  of  the  European 
war  that  American  bankers'  acceptances,  especially  those  re- 
lating to  foreign  commerce,  came  into  existence  in  substantial 
volume.  At  that  time  some  of  the  trust  companies  with  for- 
eign connections  extended  credits  freely  to  their  customers  to 
replace  credits  formerly  granted  by  European  banks  which 
had  been  either  withdrawn  or  reduced;  they  also  accepted 
drafts  in  large  volume.  On  and  after  May  18,  1914, 
member  banks  were  authorized  also  to  accept  drafts  drawn 
upon  them  involving  the  importation  or  exportation  of 
goods.  .  .  . 

The  monthly  purchases  of  acceptances  by  this  bank  [the 
Federal  Reserve  Bank  of  New  York]  in  the  New  York  mar- 
ket have  been : 


1915 

Number 
of  pieces. 

Amount. 

Number 
of  pieces. 

Amount. 

For  itself. 

For  other  reserve  banks. 

February    

4i 
140 
86 
46 
132 
106 
103 
89 
68 

"5 
310 

1,659,740.21 

3,343,143-17 
1,272,694.36 
867,420.18 
3,083,261.75 
2,496,865.67 
1,597,630.63 
1,769,880.50 

2,199,6/9.95 
1,899,606.56 
5,648,708.78 

86 
250 
84 
48 
34 
147 
89 
172 
163 
246 
3i3 

1,263,871.25 
3,799,809.42 
1,700,396.57 
i,  305,B73-8o 
602,558.89 
2,348,050.89 
1,910,417.47 
1,948,243.05 
2,028,098.36 
2,594,951.04 
2,809,823.59 

March    

April    

May   

June          

July    . 

August    

September    

October     

November    

December     

Total  

1,236 

25,833,631-76 

1,632 

22,312,094.33 

The  policy  pursued  by  this  bank  thus  far  has  been  to  pur- 
chase good  acceptances  whether  or  not  the  acceptor  was  a 
member  bank.  .  .  . 

The  reserve  bank  and  the  market  rate  for  the  discount  of 
such  bills  in  New  York  has  been  for  nearly  a  year,  and  is  now, 
lower  than  the  rate  for  similar  bills  in  London.  The  rela- 
tively small  volume  of  such  credits  which  American  banks 
have  succeeded  in  making  operative  even  under  the  unusually 
favorable  opportunity  which  the  war  presents  for  their  ex- 
tension, is  evidence  of  the  difficulty  which  will  be  encountered 


RELATIONS  WITH  MEMBERS  787 

in  developing  the  acceptance  business  in  the  United  States* 
Some  of  the  fundamental  difficulties  are: 

1 i )  The    disinclination    to    break    old    banking    connec- 
tions. 

(2)  The  difficulty  of  educating  handlers  of  bills  in  distant 
places  as  to  American  credits. 

(3)  The  lack  of  bill  buyers  in  foreign  countries  who  will 
quote  as  low  rates  on  dollar  as  on  sterling  bills. 

(4)  The  natural  prejudice  of  bill  buyers  in  foreign  countries 
in  favor  of  a  bill  of  known  currency  and  against  a  bill  of  as 
yet  unknown  currency. 

(5)  The  lack  of  men  trained  to  exercise  the  judgment  and 
financial    responsibility    required    of    them   as    managers    of 
branches  or  agencies  which  American  banks  might  establish  in 
foreign  countries. 

(6)  The  inferior  communications  for  both  goods  and  mail 
between  the  United  States  and  foreign  countries  as  compared 
with  those  between  Great  Britain  and  foreign  countries. 

Only  time,  experience,  and  patient  effort  will  remove  these 
handicaps  to  the  elevation  of  dollar  exchange  to  its  proper 
position  in  international  finance.  The  business,  however,  is 
developing  and  will  continue  to  grow  as  our  banking  machinery 
and  connections  extend  throughout  the  world. 

The  Act  permits  member  banks  to  accept  an  amount  of  bills 
not  exceeding  50  per  cent,  of  their  capital  and  surplus.  By 
the  amendment  of  March  3,  1915,  under  certain  conditions 
they  may  be  authorized  by  the  Federal  Reserve  Board  to  accept 
up  to  100  per  cent,  of  the  capital  and  surplus.  The  following 
banks  in  this  district  have  received  such  authorization : 

Amount  of 

capital  and 

surplus. 

Bank  of  New  York,  New  York $6,000,000 

Mechanics  &  Metals  National  Bank,  New  York 12,000,000 

Atlantic  National  Bank,  New  York   1,600,000 

American  Exchange  National  Bank,  New  York 8,000,000 

As  this  bank  has  probably  been  the  largest  single  purchaser 
of  bankers'  acceptances,  it  has  been  able,  as  it  gained  ex- 
perience, to  exert  some  influence  toward  standardizing  practice 
and  form. 


788  THE  FEDERAL  RESERVE  SYSTEM 

The  amended  regulation1  issued  September  7,  1915,  con- 
siderably broadened  the  field  of  acceptances  eligible  for  pur- 
chase and  encouraged  an  increased  volume  of  these  instru- 
ments. The  further  amended  regulation  issued  December  4, 
1915,  covering  the  purchase  of  bankers'  acceptances  arising 
out  of  domestic  transactions  relates  to  a  class  of  bills  which 
national  banks  are  not  authorized  to  accept  When  accepted 
by  institutions  of  high  credit  they  have  a  ready  market,  though 
at  a  fractionally  higher  rate  than  acceptances  based  on  foreign 
transactions. 

2  New  England  imports  a  large  volume  of  hides  and  wool 
from  South  America  and  cotton  and  jute  from  the  Orient 
and  other  sections  of  the  world.  These  shipments  in  the  past 
have  been  financed  through  credits  drawn  on  European  centers. 
Since  the  opening  of  the  Federal  Reserve  Banks  these  foreign 
trade  transactions  have  been  financed  to  a  large  extent  through 
dollar  credits  drawn  on  this  country  and  the  acceptances  aris- 
ing therefrom  have  found  a  ready  market  in  the  Federal  Re- 
serve Banks.  Several  of  the  member  banks  in  this  district 
have  entered  this  new  field  of  finance  an<d  the  Federal  Reserve 
Bank  of  Boston  has  used  every  effort  to  further  and  develop 
that  business,  not  only  by  buying  a  large  amount  of  that  class 
of  paper,  but  also  through  furnishing  favorable  forward  dis- 
count rates  to  assist  in  protecting  its  member  banks.  The  fol- 
lowing member  banks  have  entered  this  field : 

1.  First  National  Bank,  Boston,  Mass. 

2.  Fourth-Atlantic  National  Bank,  Boston,  Mass. 

3.  Merchants  National  Bank,  Boston,  Mass. 

4.  National  Shawmut  Bank,  Boston,  Mass. 

5.  Old  Colony  Trust  Co.,  Boston,  Mass. 

6.  Second  National  Bank,  Boston,  Mass. 

7.  Merchants  National  Bank,  Worcester,  Mass. 

Under  special  permission  of  the  Federal  Reserve  Board  the 
First  National  Bank,  of  Boston,  and  the  National  Shawmut 
Bank,  of  Boston,  have  been  given  authority  to  accept  up  to 

1  [For  regulations  issued  by  the  Federal  Reserve  Board  see  Appendix 
B.] 

2  Second  Annual  Report  of  the  Federal  Reserve  Board,  pp.  134,  135, 
1916. 


CLEARINGS  AND  COLLECTIONS  789 

100  per  cent,  of  their  capital  and  surplus.  It  is  of  interest  to 
note  that  the  former  bank  has  reported  the  largest  amount  of 
acceptances  of  any  member  bank  of  the  Federal  Reserve 
System. 

CLEARINGS  AND  COLLECTIONS  IN  PRACTICE 

1  Section  16  of  the  Federal  Reserve  Act  made  general  pro- 
vision for  the  establishment  of  a  system  of  clearance  of  checks 
throughout  the  United  States,  each  Federal  Reserve  Bank  be- 
ing required  to  act  as  a  clearing  house  for  its  members  if 
directed  by  the  Federal  Reserve  Board,  while  the  Federal 
Reserve  Board  was  authorized  to  clear  for  the  reserve  banks 
themselves. 

The  Board  had  from  the  first  recognized  its  duty  to  make 
this  provision  of  the  law  effective  as  fully  and  at  as  early  a 
date  as  conditions  would  permit;  and  in  its  first  report  spoke 
of  this  as  "  one  of  the  most  important  responsibilities  with 
which  it  is  charged  under  the  Act."  So,  regarding  its  duty 
in  this  particular,  it  undertook  early  in  1915  the  preparation 
of  a  general  circular  and  regulations  intended  to  provide  for 
the  clearing  of  checks  within  the  several  Federal  Reserve  dis- 
tricts, while  it  also  took  under  advisement  the  establishment 
of  a  gold  settlement  fund  at  Washington  for  the  purpose  of 
clearing  obligations  between  Federal  Reserve  Banks.  The 
latter  undertaking  has  been  carried  to  a  successful  conclusion 
and  the  gold  settlement  fund  has  been  in  full  and  satisfactory 
operation  since  about  the  first  of  June.  The  Board,  however, 
had  not  advanced  far  with  its  work  relating  to  the  intradis- 
trict  branch  of  the  clearance  system  before  technical  and  other 
difficulties  began  to  make  their  appearance.  Many  banks, 
both  city  and  country,  throughout  the  system  were  opposed  to 
the  enforcement  of  the  provisions  of  the  law  because  of  the 
loss  of  exchange  charges  which  would  thereby  be  entailed  upon 
them.  Legal  questions  were  also  raised,  it  being  argued  that 
there  is  no  power  to  compel  a  member  bank  not  located  in  a 
Federal  Reserve  city  to  pay  or  have  charged  to  its  account  at 
the  Federal  Reserve  Bank  of  its  district  a  check  which  it  had 

1  Ibid.,  pp.  14-17. 


790         THE  FEDERAL  RESERVE  SYSTEM 

not  seen  and  approved  prior  to  the  time  of  presentation  at  its 
own  counter.  For  the  purpose  of  ascertaining  the  Board's 
powers  in  this  connection  the  opinion  of  the  Attorney  General 
has  been  requested. 

While  the  Board  was  not  inclined  to  attach  undue  import- 
ance to  objections  based  upon  self-interest,  it  felt  that  it  must 
take  cognizance  of  all  legal  objections,  and  it  recognized  that 
the  clearing  question  was  essentially  a  reserve  problem  rather 
than  a  technical  question  or  a  mere  matter  of  administration. 
Inasmuch  as  the  Federal  Reserve  Act  had  granted  a  period  of 
three  years  within  which  to  effect  the  final  transfer  of  reserves 
to  Federal  Reserve  Banks  (balances  with  correspondents 
counting  as  reserves  in  the  meantime),  there  was  a  certain 
ground  for  objection  to  the  immediate  introduction  of  com- 
plete clearance  at  Federal  Reserve  Banks.  As.  is  well  known, 
reserve  balances  in  some  reserve  cities  have  heretofore  been 
used  for  the  purpose  of  providing  for  exchange  and  collection 
operations,  and  so  long  as  this  function  on  the  part  of  city 
correspondents  continued  there  was  some  argument  in  favor 
of  deferring  any  compulsory  application  of  par  clearance  at 
the  reserve  banks.  Study  of  the  problem,  moreover,  shows 
that,  pending  the  time  when  state  banks  enter  the  system  in 
larger  numbers,  it  may  be  necessary  for  some  member  banks 
to  collect  and  clear  through  theii;  correspondents  in  reserve 
cities. 

So  complex  was  the  situation  and  so  serious  the  difficulty 
involved  in  the  compulsory  application  of  any  system,  however 
carefully  conceived,  that  the  Board  felt  it  would  be  well  if 
member  banks  could  be  brought  to  recognize  of  their  own  free 
will  the  advantages  of  a  general  and  nation-wide  clearing  sys- 
tem—  advantages  which  would  inure  not  only  to  the  benefit' 
of  the  public  at  large,  but  ultimately  to  the  direct  benefit  of  the 
member  banks  themselves  from  the  purely  business  standpoint. 
It  therefore  took  under  favorable  consideration  the  question 
of  a  voluntary  clearing  system.  Both  the  difficulties  of  a 
compulsory  plan  and  the  probable  merits  of  a  voluntary  system 
had  been  strongly  represented  to  the  Board  by  the  governors 
of  the  respective  Federal  Reserve  Banks  who  at  various  meet- 
ings had  thoroughly  canvassed  the  whole  situation.  Under  a 


CLEARINGS  AND  COLLECTIONS  791 

plan,  proposed  by  the  governors,  which  in  most  districts  became 
effective  during  June,  1915,  provision  was  made  for  the  ac- 
ceptance at  par  by  the  Federal  Reserve  Bank  of  each  district 
of  checks  drawn  upon  any  member  bank  of  that  district  which 
had  previously  assented  to  the  provisions  of  the  scheme.  It 
was  hoped  that  a  very  large  number  of  member  banks  would 
promptly  affiliate  themselves  with  the  new  system  of  clearing 
and  that  the  natural  force  of  economic  competition  would  ulti- 
mately attract  to  it  those  who  at  first  might  hesitate. 

This  system,  as  already  stated,  became  operative  in  most 
districts  during  June,  1915.  Prior  to  this  whole  discussion, 
however,  two  districts  had  already  undertaken  the  application 
of  the  clearing  provision  of  the  law.  Early  in  December, 
1914,  district  No.  10  and  district  No.  8  (Kansas  City  and  St. 
Louis)  had  sought  and  obtained  permission  to  apply  to  their 
members  a  complete  system  of  required  clearing.  This  sys- 
tem had  been  in  full  operation  in  both  districts  prior  to  the 
general  application  of  the  voluntary  system.  Upon  the  in- 
auguration of  the  latter  the  directors  of  the  Federal  Reserve 
Bank  of  St.  Louis  deemed  it  wise  to  offer  to  their  member 
banks  the  option  of  withdrawing  from  the  clearance  system 
if  they  so  desired;  but  so  successful  had  been  the  working  of 
the  plan  that  comparatively  few  retired,  about  80  per  cent,  of 
all  continuing  their  membership.  The  Federal  Reserve  Bank 
of  Kansas  City  continued  its  required  system  as  before  for 
the  benefit  of  all  its  member  banks,  numbering  950.  As  about 
365  banks  continued  their  membership  in  the  St.  Louis  district, 
a  total  of  approximately  1,300  was  included  in  the  clearing 
system  of  the  two  districts  in  question.  Outside  of  these  two 
districts  about  1,100  member  banks  voluntarily  affiliated  them- 
selves with  the  clearing  system  within  a  short  time  after  its 
inauguration,  and  there  was  a  subsequent  net  inward  move- 
ment of  about  50  additional  members,  making  approximately 
1,150  banks  which  of  their  own  free  will  have  assented  .to  the 
voluntary  clearing  plan.  This  is  considerably  less  than  25  per 
cent,  of  the  institutions  eligible  for  membership,  and  the  pro- 
portion has  been  so  small  as  to  prove  a  severe  disappointment 
to  those  who  had  confidently  expected  that  the  foresight  and 
enlightened  self-interest  of  the  member  banks  would  speedily 


792         THE  FEDERAL  RESERVE  SYSTEM 

accomplish  the  desired  result.  Some  progress  has  been  made 
through  the  action  of  the  banks,  both  member  and  nonmember, 
in  improving  exchange  conditions  and  in  providing  for  the 
clearance  of  country  checks  at  points  where  this  practice  has 
never  before  prevailed;  but  in  the  main  comparatively  small 
advance  has  thus  far  been  made  in  rendering  effective  the 
provisions  of  the  law  requiring  the  standardization  of  ex- 
change and  clearance  practices.  This  slowness  is  largely  due 
to  the  failure  of  jobbers  and  merchants  to  appreciate  the  ad- 
vantages of  the  clearance  system  and  to  enlarge  its  member- 
ship by  insisting  that  their  own  banks  join  and  co-operate  in 
the  plan.  The  subject  has  recently  been  reopened  at  the  con- 
ferences between  the  governors  of  the  Federal  Reserve  Banks, 
the  Federal  Reserve  Agents,  the  transit  managers  of  the  re- 
serve banks,  and  the  Board  itself,  with  a  view  to  extending 
the  present  system  not  only  in  the  several  districts  themselves 
but  as  between  the  various  districts.  For  many  years  it  has 
been  lawful  for  banks  to  count  as  reserves  deposits  with  other 
banks.  It  was  never  the  intention  of  the  Federal  Reserve  Act 
that  member  banks  should  continue  the  maintenance  of  these 
reserve  accounts.  On  the  contrary,  the  full  meaning  of  the 
act  is  manifestly  opposed  to  such  an  idea.  It  is  the  plain 
conception  of  the  Act  that  the  reserve  banks  should,  to  a  very 
large  extent,  if  not  entirely,  perform  the  work  that  is  now 
being  done  by  correspondent  banks  in  this  respect.  This 
means  that  the  reserve  balances  to  be  carried  in  the  future  by 
the  reserve  banks  instead  of  by  the  correspondent  banks  should 
serve  as  the  basis  for  a  system  of  clearing  and  collecting  the 
exchanges  of  the  country.  Whatever  can  be  done  to  bring 
about  the  prompt  and  effective  use  of  this  new  system  of  bank 
settlement  will  be  done. 


BRANCHES  AND  AGENCIES 

1  The  question  of  branches  of  federal  reserve  banks  has 
received  careful  attention  during  the  past  year.  There  has 
been  intimation  from  several  quarters  that  the  establishment  of 
a  branch  at  a  given  point  would  be  acceptable  to  the  banks  of 

p.   18. 


PROPOSED  AMENDMENTS  TO  ACT  793 

that  place.  Only  in  one  instance  —  that  of  New  Orleans  — 
did  the  Board  receive  a  definite  request  from  a  Federal  Reserve 
Bank  to  establish  a  branch.  Believing  that  New  Orleans  and 
the  adjacent  territory  could  make  advantageous  use  of  this 
additional  banking  machinery,  the  Board  authorized  the  estab- 
lishment of  a  branch  of  the  Federal  Reserve  Bank  of  Atlanta 
to  be  located  in  New  Orleans,  and  this  branch  was  opened  for 
business  on  September  10.  Operations  at  the  New  Orleans 
branch  have  proceeded  satisfactorily,  and  the  institution  has 
been  of  considerable  use  to  the  l9cal  banks.  The  branch  is 
already  more  than  self-supporting. 

Investigation  and  experience  have  seemed  to  show  that,  at 
least  for  some  years  to  come,  the  organization  of  branches 
with  completely  equipped  offices,  vaults,  and  the  like,  and  with 
a  full  staff  of  salaried  officials,  will  be  too  heavy  an  expense 
for  most  of  the  reserve  banks,  yet,  that  valuable  service  could 
be  performed  by  local  offices  of  the  several  banks  in  not  a  few 
places.  The  Board  has,  therefore,  had  under  consideration 
the  question  whether  establishing  local  agencies  might  not  meet 
the  requirements  of  the  case  better  than  the  more  fully  or- 
ganized branch  office.  Competent  legal  opinion  is  to  the  effect 
that  the  creation  of  such  local  offices  is  permissible  under  the 
terms  of  the  law,  and  the  Board  believes  that  it  may  prove 
practicable  to  meet  banking  necessities  in  many  sections  of  the 
country  by  this  nieans. 

PROPOSED  AMENDMENTS  TO  FEDERAL  RESERVE  ACT  x 

A  year's  experience  in  the  operation  of  the  Federal  Reserve 
Act  has  confirmed  the  Board  in  its  profound  conviction  that 
the  act  has  been  one  of  the  most  beneficial  pieces  of  legislation 
ever  adopted  by  Congress.  Not  only  have  its  fundamental 
principles  been  fully  vindicated  but  in  most  details  the  work- 
ing of  the  measure  has  been  successful.  The  act,  however, 
is  a  progressive  piece  of  legislation  and  creates  new  conditions 
as  the  result  of  its  own  operation.  Modification  in  its  terms 
growing  in  part  out  of  these  new  conditions  will  subsequently 
be  required  from  time  to  time. 

1  Ibid.,  pp.  21,  22. 


794         THE  FEDERAL  RESERVE  SYSTEM 

For  the  present  the  Board  presents  the  following  suggestions 
for  amendments  to  the  act : 

1 i )  In  addition  to  powers  now  possessed  in  this  connection 
by  Federal    Reserve   Banks   and   national    banks,    the   latter 
should  be  permitted  to  subscribe  for  and  hold  stock  in  banks 
organized  for  the  special  purpose  of  doing  a  banking  business 
in  foreign  countries. 

(2)  With  the  approval  of  the  Federal  Reserve  Board  the 
issue  of  Federal   Reserve  notes  to   Federal   Reserve   Banks 
should  be  permitted  either  against  the  deposit  of  an  equal 
amount,  face  value,  of  notes,  drafts,  bills  of  exchange,  and 
bankers'  acceptances  acquired  by  Federal  Reserve  Banks  under 
sections  13  and  14  of  the  Act,  or  of  gold,  or  of  both,  provided, 
however,  that  gold  so  deposited  with  a  Federal  Reserve  Agent 
shall  count  as  part  of  the  reserve  required  by -the  Act  to  be 
maintained  by  the  bank  against  such  notes  outstanding. 

(3)  The  acceptance  system,  provision  for  which  is  made  in 
foreign  trade  operations  by  the  Federal  Reserve  Act,  should 
be  extended  to  the  domestic  trade  in  so  far  as  relates  to  docu- 
mentary acceptances  secured  by  shipping  documents  or  ware- 
house receipts,   covering  readily  marketable  commodities  or 
against  the  pledge  of  goods  actually  sold. 

There  can  be  but  little  question  of  the  safety  of  such  ac- 
ceptances, and  their  use  will  tend  to  equalize  interest  rates  the 
country  over  and  help  to  broaden  the  discount  market. 

(4)  Permission  should  be  granted  to  national  banks  to  es- 
tablish branch  offices  within  the  city,  or  within  the  county,  in 
which  they  are  located. 

(5)  In  order  to  enable  member  banks  to  obtain  prompt  and 
economical  accommodations  for  periods  not  to  exceed  fifteen 
days,  the  Federal  Reserve  Banks  should  be  permitted  to  make 
advances  to  member  banks  against  their  promissory  notes  se- 
cured by  such  notes,  drafts,  bills  of  exchange,  and  bankers' 
acceptances  as  the  law  at  present  permits  to  be  rediscounted  or 
purchased ;  or  against  the  deposit  or  pledge  of  United  States 
Government  bonds,  the  purchase  of  which  is  now  permitted 
under  the  law. 

(6)  The  Board  furthermore  recommends  that  the  power  of 
national  banks  to  make  loans  on  farm  lands  as  provided  in 


PROPOSED  AMENDMENTS  TO  ACT  795 

section  24  be  extended  so  as  to  permit  any  national  bank  not 
situated  in  a  central  reserve  city  to  make  loans  secured  by 
improved  and  unencumbered  farm  land  situated  within  its 
Federal  Reserve  district,  or  within  a  radius  of  100  miles  from 
the  place  in  which  such  bank  is  located,  irrespective  of  district 
lines.  It  also  recommends  that  the  powers  of  national  banks 
be  further  extended  to  permit  any  such  bank  to  make  loans 
on  any  improved  and  unencumbered  real  estate  located  within 
100  miles  of  the  place  in  which  such  bank  is  located,  irrespec- 
tive of  district  lines;  provided,  however,  that  the  aggregate  of 
farm  land  loans  and  other  real  estate  loans  made  by  any  na- 
tional bank  shall  not  exceed  25  per  centum  of  its  capital  and 
surplus  or  one-third  of  its  time  deposits ;  and  provided  fur- 
ther, that  no  such  real  estate  loan,  as  distinguished  from  a 
farm  land  loan,  shall  exceed  a  period  of  one  year  nor  exceed 
50  per  centum  of  the  actual  value  of  the  property  offered  as 
security. 

It  is  believed  that  the  enactment  of  these  amendments  will, 
besides  enlarging  the  usefulness  of  the  national  banks,  result 
in  greatly  strengthening  the  operation  of  the  Federal  Reserve 
Act,  and  more  completely  realize  the  purposes  of  its  framers. 
The  text  of  the  amendments  designed  to  carry  out  these 
recommendations  will  be  submitted  by  the  Board  at  an  early 
date.  The  Board  has  under  consideration  other  suggestions 
for  amendments  to  the  Federal  Reserve  Act  concerning  which 
no  conclusions  have  yet  been  reached,  and  regarding  which 
the  Board  will  take  occasion  to  submit  its  views  to  the  Con- 
gress at  an  appropriate  time  in  the  future. 


796 


THE  FEDERAL  RESERVE  SYSTEM 


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Capital  paid  in  
Government  deposits  .  . 
Reserve  deposits,  net  .  . 
Federal  Reserve  notes, 

All  other  liabilities  .... 

Total  liabilities  

CHAPTER  XXXII 

THE  EARLY  EVENTS  OF  THE  EUROPEAN  WAR  IN 
RELATION  TO  MONEY  BANKING  AND  FINANCE 

AMERICAN  FINANCE  AND  THE  EUROPEAN  WAR 

1  DURING  the  half-century  that  has  elapsed  since  the  Civil 
War,  there  has  probably  been  no  period  of  six  months  within 
which  there  have  occurred  transformations  of  so  far-reaching 
a  nature  in  American  banking  and  finance  as  during  the  half- 
year  between  July  i,  1914,  and  January  i,  1915.  It  will  be 
long  before  the  full  meaning  and  significance  of  these  events 
are  thoroughly  understood ;  for  what  has  been  done  cannot  be 
finally  interpreted  until  facts  which  have  not  yet  been  ascer- 
tained have  developed  their  consequences.  On  the  other  hand, 
it  would  be  impossible  to  forecast  the  ultimate  effect  of  the 
European  war  should  any  one  of  certain  tendencies  which  are 
still  at  least  possible  be  fully  carried  out.  What  has  already 
taken  place,  however,  comprises  a  range  of  events  full  of  im- 
portant lessons  and  significant  for  the  light  they  throw  upon 
the  methods  to  be  employed  in  the  near  future  in  the  manage- 
ment of  industrial  and  commercial  enterprises.  This  ex- 
perience has  been  particularly  rich  in  its  bearing  upon  the 
relationship  between  banking  and  finance  in  the  strict  sense 
of  the  terms  on  the  one  hand,  and  the  future  of  commerce  and 
industry  in  general  on  the  other.  Though  it  be  true  that  only 
hasty  thinkers  will  endeavor  to  draw  final  conclusions  from 
what  has  thus  far  occurred,  it  is,  nevertheless,  also  true  that 
much  can  be  learned  from  the  mere  marshaling  of  recent  events 
in  their  relation  one  to  another. 


Upon  the  outbreak  of  the  European  war,  it  was  at  once  evi- 
dent to  all  that  very  striking  changes  would  result  in  every 

1 H.   Parker  Willis,  American  Finance  and  The  European   War,   The 
Journal  of  Political  Economy,  Vol.  23,  No.  2,  February,  1915,  pp.  144-165. 

797 


798  EUROPEAN  WAR 

department  of  business  life.  There  was,  of  course,  at  the  out- 
set no  knowledge  of  the  strategy  or  probable  methods  to  be 
employed  by  any  of  the  belligerents,  and  the  general  attitude 
of  the  business  community  was  based  upon  the  assumption  that 
commerce  would,  for  a  time  at  least,  become  nearly  impossible. 
As  a  corollary  to  that  assumption,  there  prevailed  the  belief  in 
many  circles  that  American  indebtedness  to  foreign  countries 
would  have  to  be  liquidated  in  cash,  and  that  this  process 
would  result  in  draining  away  from  the  United  States  a  cor- 
responding amount  of  gold.  It  was  natural,  therefore,  that 
the  first  phenomenon  of  the  war  should  be  the  suspension  of 
dealings  which  it  was  believed  would  promote  this  gold  move- 
ment, or  would  cause  more  serious  trouble  in  any  direction 
than  would  otherwise  be  inevitable.  The  closing  of  the  prin- 
cipal stock  exchanges  of  the  country  almost  immediately  upon 
the  definite  announcement  that  war  was  unavoidable  was  thus 
dictated  by  two  considerations:  (i)  the  belief  that  prices 
for  stocks  and  other  securities  would  be  reduced  to  a  point  so 
low  as  to  bring  about  the  repurchase  of  the  securities  by 
Americans,  who  would  then  be  obliged  to  pay  for  them  in 
gold;  (2)  the  belief  that,  in  consequence  of  this  reduction  of 
prices,  many  bank  loans  based  upon  securities  would  have  to 
be  "  called,"  thereby  bringing  about  failures  and  incidentally 
assisting  in  the  movement  of  specie  out  of  the  country. 

In  the  case  of  the  cotton  exchanges,  it  was  at  once  perceived 
that  the  cotton  crop,  which  is  so  largely  produced  for  export, 
could  not  now  move  abroad  with  any  degree  of  facility,  and 
that  the  demand  for  cotton^would  undoubtedly  be  slack.  The 
very  fact  of  the  war,  therefore,  implied  heavy  reductions  in 
the  price  of  cotton,  and  the  closing  of  the  cotton  exchanges 
was  a  measure  of  self-preservation  on  the  part  of  the  opera- 
tors, who  decided  to  protect  themselves  against  the  inevitable 
failures  which  would  result  from  the  fulfilment  of  existing 
contracts  at  very  low  prices.  To  close  the  exchanges  would 
result  in  gaining  time,  and  would,  therefore,  enable  operators 
to  meet  their  maturing  obligations,  besides  perhaps  affording 
an  opportunity  for  actual  recovery  in  cotton  prices.  This  very 
fact,  however,  of  the  closing  of  the  exchanges  and  the  con- 
sequent removal  of  any  other  established  method  of  determin- 


EFFECTS  UPON  AMERICAN  FINANCE  799 

ing  prices  for  standard  securities  and  for  a  staple  like  cotton 
involved  most  profound  and  far-reaching  effects.  The  ex- 
changes had  closed  in  previous  years,  but  never  for  the  reasons 
which  now  controlled  them.  That  they  should  close  because 
of  the  fear  of  failure  and  the  loss  of  gold  implied  a  serious 
danger  of  disaster  which  appealed  powerfully  to  the  public 
mind,  and  which  presented  a  problem  that  could  not  be  ex- 
plained away.  The  fact  that,  coincident  with  this  closing  of 
the  exchanges,  international  trade  was  practically  suspended 
for  several  days,  and  was  seriously  interrupted  for  several 
weeks,  until  British  vessels  assumed  virtual  control  of  the 
North  Atlantic,  tended  greatly  to  increase  the  public  anxiety. 
It  formed,  apparently,  good  ground  for  the  suspension  of  busi- 
ness operations  and  for  the  non-fulfilment  of  contracts,  even 
when  the  very  difficult  conditions  did  not  themselves  compel  a 
recourse  to  such  methods.  The  fact  that  foreign  countries  had 
adopted  legislation  deferring  the  date  when  debts  need  be  paid 
or  contracts  fulfilled,  although  not  paralleled  here,  produced 
a  sympathetic  influence  upon  business  in  the  United  States, 
which  practically  resulted  in  the  partial  or  tentative  adoption 
of  a  somewhat  similar  relaxation  of  commercial  requirements 
in  many  industries  and  branches  of  trade. 

It  is  notable  that  the  Produce  Exchange  of  New  York  and 
the  other  grain  exchanges  of  the  country  continued  in  opera- 
tion and  did  an  enormous  business  in  spite  of  the  prevailing 
conditions.  This  was  due  to  the  fact  that  grain  of  all  kinds, 
provisions,  and  every  sort  of  food-stuff  were,  for  the  time 
being,  subject  to  a  very  rapid  upward  movement.  It  was 
early  perceived  that  a  long  continuance  of  the  war  would 
bring  about  a  steady  advance  in  the  prices  of  all  food  products, 
the  markets  for  which  are  not  dependent  upon  temporary 
fluctuations  for  support,  but  are  subject  to  far-reaching  and 
semi-permanent  influences.  The  fact  that  these  exchanges 
continued  open  while  those  whose  staples  were  subject  to  de- 
cline closed  so  speedily,  naturally  produced  its  own  effect  upon 
the  public  mind.  Many  who  had  thought  the  exchanges  in- 
variably faithful  registers  of  price  fluctuations  were  now  re- 
luctantly obliged  to  confess  that  this  could  not  be  the  case, 
since  those  exchanges  where  prices  were  rising  continued  to 


800  EUROPEAN  WAR 

operate  without  interruption,  while  those  where  prices  were 
falling  were  obliged  to  suspend  business.  From  one  point  of 
view,  undoubtedly,  the  closing  of  the  stock  and  cotton  ex- 
changes tended  still  further  to  deepen  the  attitude  of  dis- 
satisfaction with  these  institutions  that  had  been  prevalent  for 
some  years  among  the  American  public.  On  the  other  hand, 
however,  as  time  went  on,  it  became  clear  that  the  exchanges 
of  the  country  and  the  service  they  performed  when  in  opera- 
tion were  being  appreciated  as  never  before  by  the  conserva- 
tive popular  mind  of  the  nation.  With  the  exchanges  closed 
it  was  seen  that  the  lack  of  a  regular  and  established  market 
subject  to  natural  conditions  meant  suffering  and  inability  to 
secure  the  advantage  of  free  competition  in  the  establishment 
of  the  price  of  products.  This  view  was  once  more  empha- 
sized when,  later  on,  the  cotton  exchanges  reopened ;  for  it  was 
then  seen  that  the  effect  of  trading  upon  the  exchanges  was 
to  advance  the  price  of  the  staple  rather  than  to  lower  it,  a 
view  the  precise  reverse  of  that  which  had  been  originally 
prevalent  for  a  long  time  past.  Both  in  the  psychological,  as 
well  as  in  the  actual,  effect  of  these  closings,  and  in  the  in- 
fluence the  episode  exerted  upon  public  opinion,  the  suspension 
of  the  exchanges  throughout  the  United  States  must  be  re- 
garded as  a  fact  of  first-rate  importance  in  the  financial  history 
of  the  United  States  during  the  European  war. 

ii 

Even  without  the  suspension  of  certain  classes  of  trading 
throughout  the  country,  partially  due  as  it  was  to  the  frenzied 
demand  of  European  holders  of  American  investments  for 
money,  the  strain  thrown  upon  our  banks  as  a  result  of  the 
great  change  in  conditions  would  have  been  enormous.  The 
closing  of  the  exchanges,  as  already  seen,  had  relieved  matters 
to  some  extent  by  enabling  the  banks  to  avoid  the  calling  of 
loans,  and  thereby  to  avoid  the  necessity  of  forcing  customers 
into  liquidation,  with  the  resultant  disastrous  effect  upon  them- 
selves. But  on  the  other  hand,  the  suspension  of  operations 
and  the  corresponding  loss  by  the  public  would,  it  was  felt, 
tend  to  the  hoarding  of  legal-tender  money.  In  order  to  meet 
this  situation,  the  banks  in  many  of  the  large  financial  centres 


EFFECTS  UPON  AMERICAN  FINANCE  80 1 

sought  to  limit  specie  payments,  taking  out  emergency  currency 
and  clearing-house  certificates  for  the  purpose  of  meeting  their 
indebtedness  to  the  public  and  to  one  another.  ...  A  phase 
of  this  phenomenon  was  seen  in  the  tremendous  rise  in  foreign 
exchange  rates,  the  rates  becoming  practically  prohibitive  and 
thereby  causing  what  amounted  to  a  suspension  of  financial 
relationship  between  the  United  States  and  foreign  countries, 
particularly  Great  Britain. 

in 

It  was  early  understood  that  the  real  difficulty  and  danger  in 
the  international  situation  did  not  lie  in  the  superficial  symp- 
toms of  trouble,  but  were  found  much  deeper,  being  directly 
due  to  the  fact  that  international  business  had  been  practically 
suspended  as  the  result  of  the  war.  This  was  a  factor  of 
prime  and  material  importance  in  the  whole  situation,  because 
the  maintenance  of  established  relations  between  the  United 
States  and  foreign  countries  was  directly  dependent  upon  the 
regular  exportation  of  goods.  As  was  customary  during  the 
summer  months,  there  had  been  large  expenditures  by  Ameri- 
can tourists  in  Europe;  and  we  had  become  indebted  to  other 
countries,  particularly  Great  Britain,  for  material  sums  in  ex- 
cess of  what  we  were  currently  able  to  liquidate.  This  was 
on  the  assumption,  as  usual,  that  such  indebtedness  would  be 
liquidated  through  the  shipment  of  agricultural  products,  par- 
ticularly of  cotton,  the  country's  principal  cash  crop.  The 
breakdown  of  trade  with  Europe  through  the  inability  of.  ves- 
sels to  run  regularly  at  the  outset  of  the  war,  and  through  the 
reduction  of  buying  power,  due  to  the  interruption  of  all  reg- 
ular industrial,  commercial,  and  financial  operations,  meant 
that  in  the  absence  of  some  restoration  of  the  normal  course 
of  business  it  would  be  necessary  to  find  other  means  of 
liquidating  our  obligations  to  foreign  countries.  The  first 
phase  of  the  difficulty  was  met  by  investigating  the  extent  of 
international  indebtedness,  which,  in  the  absence  of  other 
means  of  payment,  would  necessitate  the  draining-away  of 
gold  from  the  United  States.  Such  an  investigation  was  un- 
dertaken by  the  Federal  Reserve  Board,  which,  by  sending  out 
questions  to  the  principal  international  bankers  of  the  country, 


802  EUROPEAN  WAR 

succeeded  in  forming  a  more  or  less  trustworthy  estimate  of 
the  indebtedness  on  current  accounts,  these  being,  of  course, 
of  varying  maturities  extending  over  several  months.  The 
problem  thus  raised  was  how  to  provide  for  liquidating  the 
debts  without  losing  so  much  of  the  underlying  gold  supply 
as  to  impair  the  convertibility  of  American  securities,  and 
therewith  general  confidence  in  American  ability  to  meet  obli- 
gations. The  two  chief  proposals  put  forward  for  bridging 
over  the  period  of  difficulty  were  the  establishment  of  a  joint 
gold  fund  by  the  bankers  of  the  country,  and  the  undertaking 
of  negotiations  with  Great  Britain  whereby  some  relaxation 
of  foreign  demands  on  the  United  States  might  be  arranged 
for.  These  two  phases  of  policy  may  best  be  cursorily 
sketched  at  this  point. 

Since  the  new  banks  had  not  yet  been  established  and  could 
not  be  put  .into  operation  for  some  weeks,  it  was  deemed  de- 
sirable to  furnish  a  makeshift  substitute  for  the  co-operative 
effort  which  would  have  been  available  for  the  relief  of  the 
situation  had  the  banks  been  in  existence.  It  was  therefore 
determined  to  suggest  to  a  number  of  representative  bankers 
the  establishment  of  a  joint  gold  fund  to  be  used  in  providing 
exchange  on  Great  Britain,  and  to  have  this  joint  fund  de- 
veloped at  the  earliest  possible  moment.  A  letter  was  conse- 
quently sent  out  to  the  presidents  of  clearing-house  associa- 
tions throughout  the  country,  under  date  of  September  21,  in 
which  request  was  made  for  subscriptions  to  a  fund  intended 
to  aggregate  about  one  hundred  million  dollars.  This  letter 
had  previously  been  considered  and  approved  at  meetings  of 
representative  bankers  summoned  to  meet  in  Washington  on 
September  4  and  19  respectively,  and  was,  therefore,  issued 
with- their  moral  support.  The  answer  to  this  invitation  was 
prompt  and  effective,  a  total  of  over  one  hundred  and  eight 
million  dollars  being  subscribed  and  rendered  available. 

It  was  almost  immediately  evident  that  the  operation  of  this 
fund  was  proving  decidedly  beneficial  notwithstanding  that 
only  a  comparatively  small  percentage  of  the  amount  subscribed 
was  asked  for,  and  that  a  still  smaller  percentage  was  actually 
used  to  furnish  a  basis  for  gold  shipments.  Nevertheless,  it 
seemed,  during  the  ten  days  immediately  following  the  com- 


EFFECTS  UPON  AMERICAN  FINANCE  803 

pletion  of  the  subscriptions,  as  if  there  might  be  need  for  still 
further  relief  to  the  situation.  Some  of  those  who  were 
closely  connected  with  the  administration  of  the  gold  exchange 
fund  brought  the  subject  to  the  attention  of  the  Secretary  of 
the  Treasury  and  he  extended  an  invitation  to  the  British 
Government  to  send  representatives  to  this  country  mainly  for 
the  purpose  of  considering  the  possibility  of  further  adjust- 
ment, in  the  event  that  the  United  States  did  not  succeed  in 
liquidating  its  indebtedness  to  Great  Britain  by  the  natural 
movement  of  commodities  within  a  reasonably  early  period. 
The  British  Government  designated  Sir  George  Paish  and  Mr. 
B.  P.  Blackett,  who  came  to  the  United  States  and  on  October 
23  held  a  conference  with  the  Federal  Reserve  Board.  Sub- 
sequently another  conference,  attended  by  a  number  of  repre- 
sentative bankers,  was  also  held  and  the  situation  was  dis- 
cussed in  very  great  detail.  Meantime  the  establishment  of  a 
better  understanding  with  reference  to  commodities  to  be  con- 
sidered as  contraband  and  the  more  effective  policing  of  the 
North  Atlantic  rendered  possible  the  restoration  of  trade  with 
European  nations,  and  the  development  of  the  export  trade 
proceeded  with  a  speed  which  showed  that  current  obligations 
of  the  United  States  to  Great  Britain  and  other  countries 
would  be  liquidated  at  an  early  date  without  any  necessity  for 
further  interference.  By  the  time  the  reserve  banks  were 
ready  to  open  [November  16],  exchange  sales  on  London  had 
fallen  to  normal,  and  there  was,  therefore,  no  danger  that  when 
opened  the  reserve  banks  might,  as  was  for  a  time  feared  by 
some,  find  their  gold  rapidly  drawn  away  from  them  in  order 
to  meet  the  requirements  of  the  gold  export  movement. 

In  another  way  it  was  deemed  desirable  that  the  Federal 
Reserve  Board  should  help  to  facilitate  the  restoration  of  cus- 
tomary conditions  in  the  financial  market.  Almost  immedi- 
ately after  the  outbreak  of  war  it  was  seen  that,  unless 
hostilities  should  terminate  within  a  very  much  shorter  period 
than  anyone  thought  likely,  serious  injury  would  be  inflicted 
upon  the  cotton-producing  states.  As  is  well  known,  the  cot- 
ton crop  is  largely  grown  for  export,  about  two-thirds  of  the 
total  production  of  the  United  States  being  annually  sold 
atiroad.  It  happened  that  an  unusually  large  crop  had  been 


804  EUROPEAN  WAR 

planted  and  was  approaching  maturity  at  the  moment  of  the 
outbreak  of  the  war.  This  would  in  any  event  have  depressed 
prices  of  cotton,  even  under  ordinary  conditions.  The  almost 
immediate  closing  of  the  cotton  exchanges  of  the  country  was, 
however,  precipitated  by  reason  of  the  interruption  to  the 
movement  of  cotton  and  the  general  understanding  that,  in 
view  of  the  great  area  involved  in  the  hostilities,  it  would  not 
be  reasonable  to  expect  a  normal  demand  for  the  staple  to 
manifest  itself.  With  the  exchanges  closed,  and  with  ship- 
ments of  cotton  interrupted,  the  price  was  unstable  and  ab- 
normally low,  many  sales  undoubtedly  having  occurred  at  five 
cents  per  pound.  Inasmuch  as  the  cotton  crop  is  raised  very 
largely  upon  credit,  it  was  necessary  to  provide  some  means 
whereby  the  Southern  planter  could  be  assisted  to  such  exten- 
sion of  accommodation  as  he  might  require  in  meeting  the 
obligations  he  would  ordinarily  have  provided  for  by  the  sale 
of  his  crop  in  the  open  market.  Various  suggestions  were 
brought  to  the  attention  of  the  Federal  Reserve  Board,  one  of 
them  being  that  of  Mr.  Festus  J.  Wade  of  St.  Louis,  who 
suggested,  both  to  the  Board  and  to  the  Secretary  of  the 
Treasury,  the  establishment  of,  a  cotton  loan  fund  somewhat 
similar  in  purpose  and  management  to  the  gold  exchange  fund. 
After  very  anxious  consideration,  the  conclusion  was  reached 
that  some  measure  of  the  sort  would  probably  furnish  relief 
to  cotton-growers.  Various  con  ferences  were  held  with  bank- 
ing interests  for  the  purpose  of  securing  their  co-operation 
and  advice  in  regard  to  the  matter.  Ultimately  the  bankers  of 
New  York  pledged  fifty  million  dollars  in  subscriptions  to  the 
fund,  provided  that  fifty  millions  more  should  be  raised  from 
other  bankers  in  non-cotton-producing  states.  It  was  under- 
stood that  to  the  one  hundred  million  dollars  thus  raised  should 
be  added  thirty-five  million  dollars  contributed  by  the  bankers 
of  the  cotton-producing  states  under  a  special  plan  devised  for 
that  purpose.1 

1  A  fuller  account  of  the  gold  fund  and  cotton  loan  plans  will  be  found 
in  the  First  Annual  Report  of  the  Federal  Reserve  Board,  Washington, 
January  15,  1915. 


EFFECTS  UPON  AMERICAN  FINANCE  805 


IV 

It  was  not,  however,  through  any  of  these  artificial  means 
that  real  relief  was  brought  to  the  community.  While  bank- 
ers were  laboring  to  perfect  the  gold  fund,  and  while  the 
negotiations  with  Great  Britain  were  in  progress,  foreign  trade 
was  being  re-established  through  the  effective  policing  of  the 
North  Atlantic,  the  re-establishment  of  demands,  and  the  re- 
sumption of  the  ordinary  course  of  business.  What  took 
place  during  the  months  of  August  and  September  can  be 
understood  from  .  .  .  comparative  figures  for  importation 
and  exportation  which  make  an  impressive  showing  of  the 
suffering  to  which  the  United  States  was  subjected  through 
this  decline  in  business.  With  the  opening  of  October  there 
came,  however,  a  decided  improvement.  Time  had  now  been 
given  for  the  establishment  of  normal  conditions.  .  .  . 


With  foreign  trade  in  a  fair  way  to  recover,  it  was  still 
necessary  to  secure  a  restoration  of  normal  trade  conditions 
within  the  United  States,  and  for  this  purpose  the  thing  most 
fundamentally  necessary  was  the  setting  in  motion  of  the 
federal  reserve  banking  system  which  had  been  provided  for 
by  act  of  Congress  the  23d  of  December  preceding.  The  time 
intervening  between  December  23,  1913,  and  the  opening  of 
the  war  had  been  occupied  in  carrying  out  the  preliminaries  of 
organization;  but  it  still  remained  for  the  Federal  Reserve 
Board,  the  controlling  mechanism  of  the  new  system,  to  ap- 
point officers  and  to  provide  for  the  active  operation  of  the 
banks  under  its  direction.  The  first  detail  to  which  the  Board 
necessarily  addressed  itself  was  the  completion  of  the  boards 
of  directors  of  the  several  institutions,  it  being  necessary  to 
select  and  elect  three  in  each  institution,  or  thirty-six  in  all. 
The  task  required  an  elaborate  process  of  comparison  of  the 
names  and  qualifications  of  the  several  candidates  and  was  not 
completed  until  early  in  October.  With  the  announcement  of 
the  thirty-six  directors,  it  was  possible  to  proceed  to  the  active 
opening  of  the  institutions.  The  Board  called  for  the  first 
payment  of  capital  stock  on  November  2,  and  the  Secretary 


8o6  EUROPEAN  WAR 

of  the  Treasury,  who  by  law  had  been  vested  with  that  func- 
tion, named  November  16  as  the  actual  date  for  opening.  .  .  . 

The  establishment  of  the  system  .  .  .  greatly  relieved  the 
banking  situation.  .  .  .  Sec.  19  of  the  Federal  Reserve  Act 
provided  for  a  readjustment  of  reserves  upon  a  new  and  lower 
basis.  .  .  . 

This  readjustment,  by  the  terms  of  the  law,  took  effect  im- 
mediately upon  the  establishment  of  the  new  banks,  i.  e.,  on 
November  16.  From  the  outbreak  of  hostilities  in  Europe, 
there  had  been  a  difficult  reserve  situation  in  most  of  the  finan- 
cial centers,  New  York  banks  particularly  being  much  of  the 
time  largely  under  their  reserve  requirements  because  of  the 
heavy  drafts  made  upon  them  by  interior  banks  and  by  the 
public.  The  change  in  reserve  requirements,  however,  made  a 
very  material  alteration  in  this  condition  of  affairs,  and  re- 
leased, not  only  in  New  York,  but  throughout  the  country,  a 
very  considerable  amount  of  funds  which  had  previously  been 
held  by  the  banks  in  order  to  bring  themselves  within  the 
requirements  of  law.  Precisely  what  amount  of  reserves  was 
thus  released  throughout  the  country  has  not  been  accurately 
estimated,  and  probably  cannot  be.  It  is,  however,  an  un- 
doubted fact  that  the  release  of  actual  cash  was  very  large, 
and  that  the  release  of  lending  power  as  computed  on  the  basis 
of  reserves  on  the  part  of  member  banks  was  correspondingly 
larger.  Member  banks  were  thereby  enabled  to  extend  loans 
to  their  customers  very  much  more  freely  than  they  had  pre- 
viously been  able  to  do,  while  at  the  same  time  they  were  able 
to  grant  lower  rates  of  interest  in  due  proportion.  The  pre- 
vailing rate  of  discount  for  prime  commercial  paper  in  New 
York  at  the  beginning  of  November  was  about  6  per  cent., 
while  other  paper  was  considerably  higher  than  that  figure, 
and  even  more  difficult  conditions  prevailed  elsewhere.  The 
opening  of  the  reserve  system  enabled  New  York  banks,  be- 
cause of  the  very  great  relief  given  to  them  through  the  re- 
lease of  reserves,  to  reduce  this  rate  largely,  and  within  two 
weeks  after  the  new  banks  had  come  into  existence  prevailing 
interest  rates  for  the  best  paper  went  as  low  as  3^/2  per  cent, 
and  4  per  cent,  while  acceptances,  which  had  been  provided  for 
by  the  Federal  Reserve  Act,  were  marketed  at  a  still  lower  rate. 


EFFECTS  UPON  AMERICAN  FINANCE  807 

In  some  parts  of  the  South,  Northern  bankers  were  able  to 
grant  accommodation  as  low  as  4  per  cent,  and  in  considerable 
amounts.  In  view  of  the  greater  ease  and  material  relief  which 
was  thus  accorded,  the  federal  reserve  banks  were  naturally 
not  called  upon  to  assist  member  banks  with  accommodation, 
such  banks  naturally  refraining  from  asking  aid  when  they 
themselves  were  fully  able  to  meet  the  situation. 

The  opening  of  the  reserve  banks  released,  as  already  shown, 
a  large  amount  of  bank  funds,  and  thereby  rendered  it  possible 
to  extend  many  loans  which  otherwise  could  not  have  been 
carried  by  the  banks.  It  was  also  seen,  soon  after  November 
16,  that  the  existence  of  the  cotton  fund,  as  was  the  case  with 
the  gold  fund,  had  done  its  work  by  stimulating  confidence  and 
by  leading  to  a  more  liberal  extension  of  credit.  With  the 
cotton  fund  available  for  long-time  loans,  and  with  short-term 
credit  much  more  freely  extended  by  member  banks  in  view 
of  the  reduction  of  national  bank  reserve  requirements,  it  was 
possible  for  the  reserve  banks  to  open  with  full  confidence  that 
the  work  thus  done  in  safeguarding  the  situation  would  relieve 
them  from  undue  strain,  while  fully  protecting  the  cotton- 
producers  who  were  willing  to  pay  a  moderate  rate  of  interest 
in  order  to  carry  their  cotton  until  such  time  as  would  enable 
them  to  realize  full  market  value  for  it. 

As  has  been  shown  by  the  Secretary  of  the  Treasury  in  his 
annual  report,1  an  early  phenomenon  of  the  war  was  the  issue 
by  clearing-houses  in  many  cities  of  clearing-house  certificates. 
Simultaneously  therewith  large  quantities  of  emergency  cur- 
rency were  issued  under  the  provisions  of  the  act  of  1908, 
which  had  been  amended  and  extended  by  the  Federal  Reserve 
Act,  and  which  were  still  further  amended  by  Congress  on 
August  4,  so  as  to  permit  the  freer  issue  of  notes.  .  .  .  The 
total  amount  of  the  emergency  currency  taken  out  by  associa- 
tions had  aggregated  about  three  hundred  and  eighty  million 
dollars,  but  it  is  probable  that  the  clearing-house  certificates 
were  issued  to  a  considerably  larger  sum.  The  channels  of 
circulation  were  thus  clogged  long  before  the  end  of  the  sum- 
mer, notwithstanding  the  fact  that  large  quantities  of  gold 

1  Report  of  Secretary  of  the  Treasury,  December  7,  1914. 


8o8  EUROPEAN  WAR 

and  gold  certificates  were  withdrawn  and  hoarded  either  by 
banks  or  by  individuals.  This  condition  of  affairs  made  it 
certain  that  the  reserve  banks,  upon  their  organization,  would 
not  be  instantly  pressed  for  the  issue  of  reserve  notes.  Two 
factors  combined  to  produce  this  result  —  the  circumstance 
that  many  banks  had  placed  their  best  paper  with  the  national 
currency  associations  in  order  to  protect  emergency  currency, 
and  the  further  circumstance  that  the  tax  on  this  currency  at 
the  lower  rate  established  by  Congress  would  not,  for  some 
considerable  time,  be  likely  to  approximate  the  rate  of  discount 
which  every  bank  would  have  to  pay  to  federal  reserve  banks 
in  order  to  get  the  rediscounts  that  would  enable  them  to  ob- 
tain the  notes  they  needed.  Combined  with  these  factors  was, 
of  course,  the  natural  inertia  which  in  all  such  cases  tends  to 
prevent  the  withdrawal  of  one  kind  of  currency  "and  the  issue 
of  another.  Upon  the  organization  of  the  federal  reserve 
banks,  moreover,  the  urgent  pressure  for  note  accommodation 
passed  away  as  quickly  as  it  had  come.  Gold  reappeared  in 
circulation  at  an  early  date,  and  the  retirement  both  of  the 
clearing-house  certificates  and  of  the  emergency  currency  was 
undertaken.  In  those  cities  where  rates  of  interest  on  clearing- 
house certificates  were  very  high,  the  reserve  banks  aided  in 
the  retirement  of  the  certificates  remaining  in  circulation. 

The  emergency  currency  itself  immediately  began  to  be 
retired  by  its  issuers.  .  .  .  Had  the  reserve  banks  been  in 
operation  at  the  beginning  of  August,  they  would  naturally 
have  supplied  the  great  volume  of  currency  which  was  called 
for;  but  not  having  done  so,  a  field  of  business  which  would 
naturally  be  theirs  has  been  temporarily  taken  from  them  by 
reason  of  the  fact  that  it  was  occupied  by  the  clearing-house 
certificates  and  emergency  notes.1 

VI 

The  result  of  the  restoration  of  trade,  banking,  and  credit  to 
earlier  and  more  normal  conditions  has  been  steadily  apparent. 
Cotton  exchanges  reopened  on  November  16,  and  stock  ex- 
changes opened  for  restricted  trading  shortly  thereafter.  In 
brief,  by  the  close  of  the  year,  the  phenomenal  conditions  grow- 

1  First  Annual  Report  of  the  Federal  Reserve  Board,  p.  16. 


EFFECTS  UPON  AMERICAN  FINANCE  809 

ing  directly  out  of  the  European  war  had  been  met  and  over- 
come. It  is  a  notable  fact  that  under  the  wholly  unusual 
circumstances  prevailing,  the  recovery  was  so  prompt  and  ef- 
fective. What  share  in  this  early  improvement  is  to  be  as- 
signed to  the  organization  of  the  new  banking  system  and  to 
the  effectiveness  with  which  the  Treasury  Department  co- 
operated in  meeting  the  needs  of  the  country  cannot  accurately 
be  stated,  and  will  probably  afford  grounds  for  difference  of 
opinion.  That  it  \vas  great  cannot  be  denied.  .  .  . 

NATIONAL  BANK  FAILURES  AND  SUSPENSIONS  — 
1914  COMPARED  WITH  1893  AND  I9°7  * 

A  comparison  of  the  failures  and  suspensions  of  national 
banks  during  the  past  year  \vith  failures  and  suspensions  in  the 
panic  periods  of  1893  an^  I9°7  may  De  interesting  at  this 
time. 

The  figures  show  that  for  the  12  months  ended  October 
31,  1914,  26  national  banks,  with  aggregate  capital  stock  of 
$2,510,000,  failed  or  suspended  payment.  The  total  liabilities 
of  these  banks  (in  the  case  of  receiverships  claims  proved) 
amounted  to  $14,177,408.  In  the  case  of  six  recent  failures, 
the  figures  of  total  liabilities,  less  capital,  surplus,  and  undi- 
vided profits,  are  used  in  lieu  of  the  "  claims  proved,"  no  re- 
port of  the  latter  having  yet  been  received  as  to  these  six  banks. 

For  the  12  months  ending  October  31,  1893,  158  national 
banks  suspended,  with  capital  of  $30,350,000.  Sixty-five 
banks,  with  total  capital  stock  of  $10,935,000,  were  insolvent 
and  required  the  appointment  of  receivers;  86,  with  capital 
stock  aggregating  $18,205,000,  were  able  to  resume  business; 
and  7,  with  capital  stock  of  $1,210,000,  were  placed  in  charge 
of  examiners  in  the  expectation  of  resumption.  The  total 
liabilities  of  failed  and  suspended  banks  for  the  period  men- 
tioned was  $83,042,347  —  in  the  case  of  failed  banks,  "  claims 
proved  "  being  considered  as  "  total  liabilities." 

During  the  six-months  period  from  October  i,  1907,  to 
April  i,  1908,  there  were  22  national  bank  failures  and  sus- 
pensions, and  the  total  liabilities  (in  the  case  of  receiverships 

1  Report  of  the  Comptroller  of  the  Currency,  1914,  pp.  15,  16. 


8lO  EUROPEAN  WAR 

these  being  "claims  proved")  were  $32,443,978;  the  total 
capital  stock,  $6,540,000.  Of  these  banks,  however,  7,  with 
capital  stock  of  $1,440,000  and  liabilities  of  $22,124,662,  re- 
sumed business. 

It  is  worthy  of  special  note  that  in  the  crisis  of  1914,  unlike 
the  panics  of  1893  and  1907,  there  was  no  suspension  of  cur- 
rency payments  on  the  part  of  the  banks  of  this  country,  either 
in  the  large  cities  or  in  the  smaller  towns.  In  the  panics  of 
1893  and  1907,  in  addition  to  clearing-house  checks,  many 
artificial  methods  of  supplying  a  temporary  currency  were  re- 
sorted to,  while  actual  currency  commanded  a  premium  of 
from  3  per  cent,  to  5  per  cent. —  $100  in  currency  costing  any- 
where from  $103  to  $105,  or  more,  in  certified  bank  checks. 

In  1914  the  banks  of  the  country  were  enabled,  as  a  result 
of  the  instant  and  active  co-operation  of  the  Treasury  De- 
partment, and  through  the  operations  of  the  act  of  May  30, 
1908,  as  amended  by  the  Federal  Reserve  Act,  to  supply  actual 
currency,  even  during  the  period  of  greatest  stringency,  to  their 
customers  and  correspondents,  both  over  the  counter  and  in 
response  to  requests  for  shipments.  Whenever  any  indica- 
tions were  seen  of  an  attempt  or  disposition  on  the  part  of  any 
solvent  bank  or  banks  to  withhold  or  suspend  cash  payments, 
the  subject  was  taken  up  immediately  by  the  Treasury  Depart- 
ment, and  payments  of  currency  over  the  counter  and  ship- 
ments by  the  banks  upon  demand,  from  the  centers  to  the  near- 
by and  far-off  districts,  and  vice  versa,  have  been  maintained 
practically  without  interruption  throughout  this  crisis. 

THE  EFFECTS  OF  THE  WAR  WITH  SPECIAL  REFERENCE  TO 

THE  CENTRAL  BANKS  OF  FRANCE,  GERMANY, 

AND  ENGLAND 


1  In  France  the  gold  held  by  the  Bank  of  France  (February, 
1916)  is,  in  actual  quantity,  larger  by  about  25  per  cent,  than 
that  held  in  normal  times  before  the  war.  Instead  of  former 
gold  reserves  of  about  $800,000,000,  they  are  now  well  over 

1J.  Laurence  Laughlin,  Will  the  Gold  Basis  Survive  in  Europe f,  The 
Annalist,  Vol.  7,  No.  162,  Feb.  21,  1916,  pp.  244,  252. 


EFFECTS  UPON  BANK  OF  FRANCE         8ll 

$1,000,000,000.  The  percentage  of  gold  to  the  notes  —  the 
main  demand  liability  —  has,  of  course,  fallen  from  about  65 
to  35  per  cent,  because  of  the  increase  of  notes  from  about 
$1,200,000,000  to  $2,800,000,000. 

This  increased  supply  of  gold  has  come  from  hoardings 
and  private  holdings  which  have  been  placed  at  the  disposal  of 
the  bank  in  return  for  banknotes.  There  has  been  no  reduc- 
tion of  this  gold  fund  through  demands  from  noteholders, 
since  the  bank  was  freed  from  redemption  in  gold  at  the  very 
beginning  of  the  war.  That  is,  notes  of  the  Bank  of  France 
are  inconvertible.  As  contrasted  with  the  dollar  of  the  United 
States,  when  expressed  in  bills  of  exchange  between  New  York 
and  Paris,  the  Bank  of  France  note  has  depreciated  nearly  14 
per  cent.  Any  paper  money  not  having  immediate  redemption 
will  depreciate.  As  regards  the  future  it  is  a  question  of 
ultimate  redemption. 

With  so  large  an  available  gold  supply,  there  can  be  little 
question  as  to  the  future  intention  or  probability  of  redeeming 
the  notes  in  gold.  It  looks  very  much  as  if  the  same  policy 
adopted  in  the  war  of  1871-3  had  been  consciously  followed. 
Then,  also,  the  cours  forcee  was  declared,  and  the  gold  care- 
fully retained  in  the  vaults  of  the  bank.  The  presence  of  a 
large  gold  fund  was  an  assurance  of  the  ability  to  return  to 
specie  payments  after  the  close  of  the  war.  The  war  was 
short,  and  the  notes  were  not  seriously  depreciated,  bearing  a 
discount  as  compared  with  gold  of  il/2  to  4  per  cent.  In  the 
present  war,  the  same  steps  have  been  taken;  but  this  war  is 
extending  over  a  much  longer  time  than  the  former  one,  and 
the  depreciation  has  already  become  much  greater. 

It  is  equally  clear,  however,  that  if  the  gold  were  now  to  be 
paid  out  for  redemption  uses,  it  would  become  scattered,  ex- 
ported, and  might  even  pass  through  Holland  or  Switzerland 
into  Germany.  The  increase  and  preservation  of  this  large 
fund  of  gold  is  the  strongest  evidence  of  the  ability  of  the 
bank  to  resume  the  gold  redemption  of  its  notes  soon  after 
the  close  of  the  war.  The  actual  time,  however,  will  depend 
upon  the  rapidity  with  which 'the  Government  can  repay  some 
of  its  large  loans  from  the  bank,  since  the  excessive  note  issues 
have  been  largely  due  to  loans  to  the  State. 


812  EUROPEAN  WAR 


II 

In  Germany,  likewise,  every  effort  has  been  made  to  ac- 
cumulate gold,  even  though  the  notes  of  the  Reichsbank  were 
made  inconvertible  at  the  beginning  of  the  war.  Not  only 
was  the  requirement  to  redeem  the  notes  in  coin  removed,  but 
the  regulations  regarding  a  tax  upon  all  notes  uncovered  by 
a  specie  beyond  a  specified  Kontingent  were  suspended.  Thus, 
restrictions  on  the  limit  of  note  issues  do  not  exist;  and  they 
have  risen  from  about  $500,000,000  before  the  war  to  about 
$1,500,000,000  (February,  1916),  while  the  stock  of  coin 
and  bullion  has  changed  from  about  $300,000,000  to  over 
$600,000,000.  That  is,  the  coin,  which  is  mostly  gold,  is 
about  40  per  cent,  of  the  notes.  Here,  again  there  is  an  obvi- 
ous tendency  to  increase  and  maintain  the  gold  reserves  so  that 
Germany  may  have  the  means  of  resuming  gold  payments  at 
no  great  time  after  the  close  of  the  war. 

The  campaign  to  collect  gold  from  the  public  and  from 
hoards  was  remarkable.  It  was  successfully  made  a  test  of 
patriotism  to  hand  in  gold  in  return  for  Reichsbank  notes,  and 
a  house-to-house  canvass  in  many  places  resulted  in  providing 
the  gold  which  so  signally  increased  the  reserves  behind  the 
notes.  Of  course,  the  usual  international  operations  for  ob- 
taining gold  were  denied  to  Germany.  It  was  this  campaign 
which  was  imitated  by  France.  At  the  present  time,  certainly, 
no  thought  has  ever  occurred  to  Germans  that  they  would  not 
go  back  to  a  gold  basis. 

Nevertheless,  Germany  has  clearly  fallen  into  the  same  con- 
fusion of  mind  which  characterized  our  own  policy  in  regard 
to  the  issue  of  greenbacks  in  the  Civil  War.  We  confused 
the  monetary  with  the  fiscal  functions  of  the  Treasury.  So 
has  Germany.  Thinking  the  war  would  be  short  and  decisive, 
to  be  followed  by  large  indemnities  levied  on  her  enemies,  she 
had  expected  to  finance  her  expenditure  by  temporary  expedi- 
ents. That  is,  the  Government  was  led  into  the  policy  of  bor- 
rowing through  the  increase  of  monetary  forms. 

It  does  not  change  the  principle  that  this  increase  of  paper 
money  was  not  made  solely  by  Imperial  Treasury  notes,  but 
by  a  very  large  addition  to  the  circulation  in  the  form  of 


EFFECTS  UPON  GERMAN  FINANCE  813 

Reichsbank  notes  and  Darlehnskassen  notes.  It  was  the  loans 
by  the  Reichsbank  to  the  Government  which  undoubtedly 
caused  the  main  increase  in  the  notes  of  this  bank  (just  as  was 
true  of  the  Bank  of  France),  and  the  reduction  of  these  issues, 
and  their  redemption  in  gold, -will  depend  directly  on  the  power 
and  readiness  of  the  Government  to  pay  off  its  obligations  to 
the  Reichsbank  after  the  war. 

The  amount  of  borrowing  by  processes  which  led  to  an  in- 
crease of  the  circulation  was  necessarily  limited ;  and  very  soon 
borrowing  through  issues  of  paper  money  had  to  be  followed 
by  regular  fiscal  operations  in  the  form  of  long-  or  short-term 
bonds  which  would  not  affect  the  quantity  of  the  circulation. 
Expenses  could  not  well  be  met  to  any  extent  by  current  taxa- 
tion, because  taxes  were  already  high,  and  in  the  few  years 
before  the  war,  no  doubt  in  anticipation  of  it,  some  four 
or  five  hundred  million  dollars  in  taxes  over  and  above  nor- 
mal taxation  had  already  been  levied.  In  1913  a  non-recur- 
ring tax  of  $250,000,000  had  been  imposed  on  the  wealthier 
classes. 

In  addition  a  bonded  debt,  since  the  war,  has  been  floated  to 
to  the  amount  of  $10,000,000,000  over  and  above  the  existing 
public  debt  before  the  war  of  about  $1,200,000,000.  But  all 
these  fiscal  operations  should  be,  for  our  present  purposes, 
separated  from  monetary  operations.  The  carrying  of  these 
heavy  government  debts  is  a  question  of  the  future  production 
of  goods,  of  commerce,  and  of  saving. 

Whatever  the  burden  of  debts,  the  gold  question  is  con- 
cerned with  the  mechanism  of  exchange  by  which  taxes,  sub- 
scriptions to  loans,  payments  by  the  Government  for  munitions 
and  supplies,  current  purchases  of  goods  by  the  public,  pay- 
ments to  and  by  banks,  are  made.  At  present  this  medium  is 
paper  money  depreciated,  as  in  the  case  of  the  Reichsbank 
notes,  by  nearly  30  per  cent.  Of  course,  the  Darlehnskassen 
issues  would  follow  the  value  set  by  the  notes  of  the  Reichs- 
bank. 

It  is  interesting  to  mention  that  the  increase  of  paper  money 
has  not  been  in  answer  to  any  need  of  the  public  for  additional 
media  of  exchange;  for  ordinary  business  transactions  have 
decreased,  and  would  require  a  less  quantity  of  money.  It 


814  EUROPEAN  WAR 

was  an  error  not  to  separate  borrowing  entirely  from  mone- 
tary issues. 

Moreover,  as  bearing  on  the  maintenance  of  the  gold  stand- 
ard after  the  war,  it  is  worth  noting  that  the  rule  requiring 
the  Reichsbank  to  keep  one-third  of  its  note  issues  covered  by 
gold  has  not  been  violated.  At  last  reports  (February,  1916) 
the  gold  item  stood  at  $613,750,000,  as  against  $1,612,500,000 
notes,  or  about  38.1  per  cent.  That  is,  the  greatest  efforts 
have  been  made  to  concentrate  the  gold  holdings  of  the  nation, 
including  the  "  war  chest  "of  about  $30,000,000,  in  the  re- 
serves of  the  Reichsbank. 

At  the  same  time  no  gold  is  paid  out  in  redemption  of  notes, 
nor  is  it  allowed  to  be  exported.  Some  sums  have  been  sent 
to  Holland  in  a  vain  attempt  to  support  German  exchange  in 
that  country;  but  the  difficulty  in  exchange  rates  lies  deeper 
than  the  relative  supply  of  and  demand  for  bills,  since  the  de- 
preciation of  German  paper  money  determines  the  general 
level  about  which  the  fluctuations  of  exchange  due  to  demand 
and  supply  range.  In  fact,  wherever  gold  is  not  freely  moved 
in  internat.ional  exchange  there  are  no  shipping  points,  and 
hence  no  limits  to  which  exchange  can  fall  short  of  the  dis- 
count of  the  paper  in  terms  of  gold. 

in 

As  regards  Great  Britain,  the  gold  standard  is  yet  preserved 
for  all  practical  purposes.  To  her  credit  be  it  said  that  she 
has  not  fallen  into  the  error  of  borrowing  by  excessive  issues 
of  paper  money;  so  far  she  has  not  confused  the  fiscal  with 
the  monetary  functions  of  the  Treasury.  She  resorted  at 
once  to  fiscal  operations  in  the  form  of  heavy  taxation  and 
loans  in  the  form  of  short-time  Treasury  bills  and  longer-term 
bonds.  The  issue  of  government  paper  money  is,  indeed,  a 
new  departure ;  but  its  purpose  has  been  more  distinctly  mone- 
tary than  fiscal. 

The  currency  notes  are  emergency  notes,  issued  under  the 
act  of  August  6,  1914,  directly  by  the  Treasury,  and  not  by 
the  Bank  of  England,  although  authorized  by  the  same  act 
which  suspended  the  Bank  Act  in  regard  to  additional  issues 
of  bank  notes  not  covered  by  gold.  In  other  crises  the  act 


EFFECTS  UPON  ENGLISH  FINANCE  815 

of  1844  has  been  suspended  to  allow  more  notes  based  on  con- 
sols than  permitted  by  the  act  (».  e.,  above  the  £18,750,000), 
In  August,  1914,  such  a  suspension  was  in  the  future  made 
legal,  if  authorized  by  the  Treasury,  thus  avoiding  the  old 
resort  to  a  bill  of  indemnity  by  Parliament. 

But  in  spite  of  the  usual  suspension  of  the  Bank  Act,  no 
use  was  made  of  it.  That  is,  a  demand  for  more  currency 
in  the  hands  of  the  public  could  have  been  supplied  by  the 
bank,  but  was  not.  In  truth,  the  Lloyd  George  currency  notes 
need  not  have  been  issued.  Nevertheless,  when  once  issued, 
they  made  unnecessary  any  resort  to  additional  Bank  of  Eng- 
land notes.  There  was  no  need  of  both.  But  in  one  respect 
the  currency  notes  helped  to  maintain  the  country's  gold  stand- 
ard. By  issuing  them  in  small  denominations  of  one  pound, 
and  ten  shillings,  they  replaced  the  gold  in  general  use  for 
these  denominations,  and  allowed  it  to  be  used  as  reserves. 
Yet,  it  must  be  remembered  that  sound  policy  required  a  gold 
reserve  (which  has  been  generally  kept  at  about  40  per  cent.) 
behind  these  currency  notes,  so  that  the  whole  amount  of  gold 
replaced  was  not,  in  fact,  a  gain. 

As  all  know,  the  question  of  gold  for  Great  Britain  pivots 
on  the  reserves  of  the  Bank  of  England,  which  is  the  agent 
for  the  Government,  receiving  its  taxes  and  paying  out  its  ex- 
penses, as  well  as  the  holder  of  reserves  for  other  banks  — 
being  thus  a  bankers'  bank,  as  well  as  a  national  agent. 
Moreover,  the  reserves  mentioned,  and  which  are  of  prime 
importance,  are  those  of  the  banking  department  —  and  these 
are  chiefly  Bank  of  England  notes  (not  gold).  The  percent- 
age of  reserves  to  deposits,  which  marks  the  safety  line  for 
England,  refers  to  the  items  in  the  banking  department. 
These  notes,  however,  are  protected  (except  the  bottom  layer 
of  £18,750,000  covered  by  consols),  pound  for  pound,  by  gold 
in  the  issue  department.  Hence,  they  can  be  turned  into  gold 
at  any  moment. 

Then,  to  what  do  these  facts  lead  us?  Simply  that  gold 
has  increased  just  in  proportion  to  the  issue  of  bank  notes. 
In  addition,  the  currency  notes  of  the  Government  served  in 
the  place  pro  tanto  of  the  Bank  of  England  notes.  Hence,  at 
the  end  of  the  war,  the  provision  for  redemption  of  Bank  of 


816  EUROPEAN  WAR 

England  notes  will  work  automatically.  Nor  can  there  be  any 
question  as  to  the  gold  being  there  to  redeem  them ;  for  they 
cannot  get  out  without  a  previous  deposit  of  gold.  Indeed, 
the  questions  of  difficulty  cannot  arise  regarding  the  basic  cur- 
rency of  Great  Britain;  they  will  arise,  if  at  all,  in  connection 
with  the  assets  in  the  loan  item  of  the  banking  department, 
since  they  will  determine  the  safety  of  the  deposits  chiefly 
created  as  the  result  of  loans.  The  bank  discounted  large 
sums  of  pre-moratorium  acceptances  and  paper;  and  yet  even 
in  these  assets  it  is  protected  by  the  guarantee  of  the  Govern- 
ment. 

DARLEHNSKASSEN   AND   OTHER   FINANCIAL    NOVELTIES   IN 

GERMANY 

1  Germany,  at  the  outbreak  of  the  war,  removed  the  limit  of 
notes  issuable  by  the  Reichsbank  without  tax;  created  about 
i, 800  Darlehnskassen  (loan  banks),  located  throughout  the 
Empire,  wherever  the  Reichsbank  maintained  a  branch ;  they 
were  started  without  capital,  in  lieu  of  which  they  issued 
Darlehnskassen  Schcine  (Imperial  Loan  Bank  notes)  in  de- 
nominations of  one  mark  and  upwards,  the  aggregate  amount 
being  limited  to  1,500,000,000  marks;  these  banks  made  loans 
against  stocks,  shares,  produce,  any  personal  property  of  a 
non-perishable  character,  as  collateral,  and  issued  certificates, 
having  the  quality  of  bank  notes,  to  the  borrowers;  the  loans 
ran  for  three  and  sometimes  six  months;  the  minimum  loan 
was  100  marks;  a  very  mide  margin  of  safety  was  required, 
making  the  loans  good  beyond  question ;  these  certificates  were 
receivable  for  public  dues  and  by  the  Reichsbank ;  the  smaller 
denominations  circulated  as  money,  the  Reichsbank  received 
the  larger,  giving  its  notes  in  exchange ;  these  certificates  were 
not  legal  tender,  but  were  given  the  quality  of  gold  and  "  may 
be  considered  by  the  Reichsbank  as  gold  cover,  which  means 
that  against  100  marks  of  these  Scheine  in  its  vault  the  Reichs- 
bank is  allowed  to  issue  300  marks  of  its  own  notes."  (I.  De 
Bruyn.)2.  -  . 

1  A.  Barton  Hepburn,  A  History  of  Currency  in  the  United  States,  pp. 
463-466.     The  Macmillan  Company.     New  York.     1915. 

2  Of  Boissevain  Co. 


IMPERIAL  LOAN  BANKS  817 

Sir  Edward  H.  Holden,  president  of  the  London  City  and 
Midland  Bank,  in  a  speech  to  his  board  of  directors,  January 
29,  1915,  said: 

Germany  proceeded  to  establish  War  Loan  Banks,  War  Credit 
Banks  and  War  Aid  Banks  under  the  patronage  of  corporations, 
municipalities  and  private  financiers,  and  to  make  use  of  the  Mort- 
gage Banks  already  established.  .  .  . 

The  Mortgage  Banks  are  under  the  control  of  Chambers  of  Com- 
merce and  municipalities,  and  they  make  advances  on  the  mort- 
gage of  properties  by  an  issue  of  notes.  .  .  . 

Germany  made  greater  use  (than  of  the  Darlehnskassen)  of  the 
Mortgage  Banks,  the  notes  of  which  are  identical  in  power  and  use 
with  the  notes  of  the  Darlehnskassen.  Another  part  of  their 
scheme  was  to  relieve  the  pressure  on  insurance  companies  (life), 
by  forming  an  insurance  bank,  which  advanced  40  per  cent,  on  the 
value  of  policies.  These  advances  were  paid  on  notes  which  were 
exchanged  for  Reichsbank  notes  in  the  same  way  as  the  notes  of  the 
Darlehnskassen  and  Mortgage  Banks. 

Germany,  with  characteristic  system  and  detail,  provided 
different  kinds  of  banks  to  deal  with  different  phases  of  the 
situation.  War  credit  banks  were  designed  to  aid  Germans 
whose  credits  became  unavailable,  owing  to  the  exigencies  of 
the  war,  as  for  instance  those  who  had  sold  and  shipped  goods 
abroad  (the  enemy's  country),  whose  accounts  would  be  tem- 
porarily uncollectible,  and  those  who  might  be  otherwise  em- 
barrassed in  their  foreign  trade  because  of  the  interruption  of 
business  caused  by  the  war.  War  credit  banks  were  more 
general  in  their  dealings  than  war  loan  banks.  In  Germany, 
business  is  largely  done  upon  credit,  and  especially  so  by  small 
concerns  and  individuals,  who  possess  no  extended  bank  credit 
nor  available  collateral,  and  hence  are  not  in  position  to  make 
use  of  the  Reichsbank  or  other  commercial  banks,  or  the 
Darlehnskassen. 

A  German  banker  says :  "  It  was  deemed  advisable  to  cre- 
ate an  institution  of  an  intermediary  character  which  would 
bear  the  greater  share  of  the  risks  involved.  The  so-called 
war  credit  banks  are  designed  to  serve  this  purpose.  They 
were  established  throughout  the  country,  have  their  own  cap- 
ital, and  the  obligations  undertaken  by  them  are  guaranteed, 
and  losses,  if  any,  refunded  by  the  respective  municipalities 


8l8  EUROPEAN  WAR 

and  commercial  associations.  The  war  credit  bank  of  Greater 
Berlin,  for  instance,  was  established  with  a  capital  of  18  mil- 
lions of  marks,  of  which  25  per  cent,  are  fully  paid  in.  In 
addition  thereto,  there  is  a  liability  of  11.5  million  marks  by 
official  bodies  of  commercial  organizations." 

Still  another  kind  of  war  credit  bank  was  created  on  the 
co-operative  plan  to  assist  the  middle  and  lower  classes. 

Through  the  instrumentality  of  these  institutions,  a  large 
amount  of  credit  instruments,  possessing  a  currency  function, 
was  brought  into  existence  in  Germany.  .  .  . 

THE  WAR  AND  THE  WORLD'S  FINANCIAL  CENTRE 

1  With  the  end  of  the  moratorium  on  November  4,  it  may 
be  said  that  the  crisis  produced  by  the  outbreak  of  war  was 
over.  When  peace  comes  and  prices  [of  securities]  adapt 
themselves  to  the  new  price  of  capital  that  the  present  destruc- 
tion of  some  eight  to  ten  millions  of  it  a  day  will  bring  about, 
and  creditors  begin  to  try  to  collect  debts  from  impoverished 
debtors  in  war-wasted  countries,  then  there  will  be  a  new  set 
of  problems,  the  acuteness  of  which  will  largely  depend  on  the 
length  of  the  war  and  the  extent  to  which  the  fighters  are  worn 
out.  These  problems  will  exercise  all  the  ingenuity  and 
strength  that  Lombard  Street  can  muster.  For  the  present  it 
is  enough  to  see  how  we  stand  at  the  end  of  the  opening  period 
of  the  war,  and  what  have  been  the  effects  of  the  financial 
tornado  with  which  its  beginning  was  heralded.  .  .  . 

The  crisis  of  last  August  was  the  greatest  evidence  of  Lon- 
don's strength  as  a  financial  centre  that  it  could  have  desired 
or  dreamt  of.  It  was  so  strong  that  it  did  not  know  how 
strong  it  was.  Consequently,  being  a  little  flustered  by  the 
suddenness  of  the  outbreak  of  war,  on  a  scale  that  mankind 
had  never  seen  before,  it  made  the  mistake  of  asking  its  debtors 
to  repay  it,  not  the  thousands  of  millions  that  it  had  lent  in 
the  form  of  permanent  investment,  but  the  comparatively 
trifling  amount  —  perhaps  150  or  200  millions  —  that  it  had 
lent  in  the  shape  of  bills  of  exchange  drawn  on  it,  and  other 

1  Hartley  Withers,  War  and  Lombard  Street,  pp.  98-111.  E.  P.  Dutton 
?ind  Company.  1915. 


THE  WORLD'S  FINANCIAL  CENTER  819 

forms  of  short  credits.  Thereby  it  put  the  rest  of  the  eco- 
nomically civilized  world,  for  the  time  being,  into  the  bank- 
ruptcy court,  and  so,  finding  that  none  of  its  debtors  could  pay, 
it  thought  itself  obliged  to  ask  for  time  from  its  own  creditors 
at  home.  Foreign  creditors  it  had  none,  except  Paris.  It 
sent  gold  to  Paris  as  fast  as  it  could  be  shipped  and  insured, 
and  so  seems  to  have  liquidated  its  debt.  For  when  a  market 
in  exchange  reopened  after  the  first  shock  of  war,  the  Paris 
cheque  soon  steadied  itself  at  a  more  or  less  normal  level,  above 
the  point  at  which  gold  could  be  sent  to  France  as  an  exchange 
operation.  It  is  possible,  however,  that  London  was  still  in 
debt  to  Paris,  and  that  Paris  preferred  for  obvious  reasons  to 
leave  its  money  on  this  side  of  the  Channel. 

Of  the  three  possible  rivals  to  London  as  a  financial  centre, 
Paris  was  the  only  one  that  gave  any  evidence  of  real  financial 
strength.  Behind  Paris  stands  the  enormous  power  of  the 
thrifty  French  investor,  who  probably  accumulates  a  greater 
proportion  of  his  income  than  anybody  in  the  world,  except, 
perhaps,  some  classes  of  Scotsmen.  This  accumulating  power 
of  the  French  gives  the  Paris  money  market  a  position  of  first- 
rate  importance  in  the  financial  world,  because  capital  has  to 
be  saved,  and  a  saving  people  has  capital  to  lend.  The  ad- 
vantage that  London  holds  in  its  more  elastic  credit  system  is 
partly  balanced  by  the  advantage  given  to  Paris  by  the  thrifty 
habits  of  the  French  people.  If  Paris  adopted  a  more  busi- 
nesslike policy  with  regard  to  her  huge  store  of  gold,  which 
she  has  hitherto  seemed  to  regard  as  a  precious  asset  to  be  sat 
on  and  protected  by  the  charge  of  a  premium  to  audacious 
people  who  want  to  withdraw  a  bit  of  it,  she  might,  in  normal 
times,  be  a  much  more  dangerous  rival  to  London  than  she  is. 
But  it  need  hardly  be  said  that  Paris,  as  a  financial  centre,  was 
soon  wrapped  in  the  cloud  of  war  and  invasion,  and  had  no 
chance  of  making  any  effort  to  oust  London  from  her  pride 
of  chief  place. 

Berlin  was  equally  cut  off  from  competition,  for  Berlin  had 
to  devote  herself  to  the  task  of  financing  war  for  Germany. 
Moreover,  the  rapid  depreciation  in  the  value  of  the  mark  that 
took  place  before  the  war  began  showed  that  Germany  was 
still  a  debtor  country  in  the  short-loan  market.  The  Berlin 


820  EUROPEAN  WAR 

exchange,  while  war  was  as  yet  only  a  dreaded  possibility,  rose 
from  20  m.  50  pf.  to  20  m.  60  pf.  Germany  invests  money 
abroad,  but  she  seems  to  borrow  as  much,  and  more,  in  the 
discount  markets  of  London  and  Paris.  So  it  came  to  pass 
that,  in  spite  of  the  big  sales  of  securities  that  she  had  thrown 
on  the  markets  of  New  York  and  London,  she  still  had  to  pay 
when  the  big  day  of  settlement  came,  and  to  pay  so  fast  that 
she  had  not  a  bill  on  London  left  to  pay  with. 

It  was  the  chance  of  a  century  for  New  York.  American 
ambition  has  long  ago  informed  the  world  that  the  United 
States,  having  been  the  world's  granary,  is  now  the  world's 
most  progressive  manufacturer,  and  means  soon  to  be  the 
world's  banker.  This  may  happen  some  day,  and  might  have 
happened  already  if  American  policy  in  currency,  financial 
and  fiscal  matters  had  been  more  enlightened,  and  if  her  people 
had  been  more  thrifty.  But  they  have  tied  their  credit  system 
in  the  bonds  of  narrow  banking  laws  and  their  trade  in  those 
of  a  cramping  tariff.  These  bonds  they  have  just  begun  to 
shake  off,  and  if  the  crisis  had  happened  a  few  years  later  they 
might  perhaps  have  made  a  bid  for  London's  place  as  world 
banker.  But  it  is  hardly  likely,  for  the  development  of  the 
enormous  resources  of  the  country  still  craves  for  much  more 
capital  than  its  people  can  provide.  The  United  States  is 
still  a  debtor  to  the  world  at  large  and  seems  likely  to  be  so 
for  some  time  to  come,  and  it  is  doubtful  whether  even  New 
York,  with  all  its  skill  in  the  jugglery  of  finance,  can  make 
itself  a  great  banking  centre  as  long  as  its  heavy  balance  of 
indebtedness  is  always  waiting  to  turn  the  world's  exchanges 
against  it,  whenever  the  monetary  sky  is  overcast. 

It  was  the  chance  of  a  century,  but  New  York  could  not 
take  it.  When  London  called  in  its  credits  from  other  coun- 
tries, any  centre  that  could  have  said  to  these  countries,  "  We 
will  give  you  the  credit  that  London  has  cut  off,  and  lend  you 
the  money  to  pay  London,"  would  have  stepped  straight  on  to 
London's  financial  throne  and  set  London  a  very  difficult  task 
to  regain  it  after  the  war  was  over.  In  spite  of  the  large 
amounts  of  gold  taken  from  America  to  Europe  before  the 
war,  the  United  States  had  still  a  huge  store  within  its  borders 
—  some  estimates  of  it  ranged  up  to  400  millions  sterling. 


THE  WORLD'S  FINANCIAL  CENTER  821 

If  the  United  States  had  had  the  courage  to  use  this  mountain 
of  metal  and  let  other  countries  draw  on  it,  London  would 
have  had  more  gold  than  it  knew  what  to  do  with,  and  New 
York  would  have  had  a  big  slice  of  London's  business.  The 
United  States  were  at  peace,  and,  with  all  the  chief  countries 
of  this  antiquated  hemisphere  engaged  in  the  mediaeval  busi- 
ness of  killing  one  another's  citizens  and  destroying  one  an- 
other's property,  the  United  States  might  have  been  expected 
to  leap  into  the  position  of  economic  leadership.  But  America 
feared  to  use  its  gold,  and  held  on  to  it  as  tightly  as  it  could, 
fearful  of  internal  trouble  and  a  run  on  its  banks  if  too  much 
of  the  metal  went  abroad.  In  New  York,  as  in  most  other 
centres,  the  question  of  the  moment  was,  not  to  take  Lon- 
don's business,  but  to  pay  what  she  owed  to  London  and  to 
buy  bills  on  London  at  skyrocket  prices  wherever  they  could  be 
found.  The  strength  of  the  fat  old  money-lender,  whom  the 
Australian  papers,  angry  with  him  because  he  did  not  lend 
fast  enough,  used  to  call  John  Bull  Cohen,  was  never  more 
wonderfully  made  manifest.  Strength  in  money  bags  is  not 
everything  —  very  far  from  it  —  but  at  least  J.  B.  Cohen  can 
claim  that  he  has  made  good  use  of  it.  He  has  peopled  and 
fertilized  the  uttermost  ends  of  the  earth  with  his  sons  and  his 
capital,  and  he  alone  among  the  nations  has  had  the  courage 
and  the  homely  wit  to  throw  his  ports  open  to  all  and  to 
tell  all  the  peoples  of  the  world  to  send  their  stuff  along 
if  it  is  worth  buying.  Moreover,  he  has  lately  shown  that, 
in  spite  of  all  his  alleged  decadence,  he  can  still  tuck  up 
his  sleeves  on  occasion  and  fight  at  least  as  well  as  anybody 
else. 

So  far  was  New  York  from  being  able  to  supplant  London 
that,  as  we  have  seen,  the  United  States  had  to  make  special 
arrangements  to  tide  over  the  difficulty  which  London's  claims 
on  her  had  produced.  .  .  . 

The  American  Government  found  it  necessary  to  ask  offi- 
cials of  the  British  Treasury  to  come  over  and  help  it  to  find 
ways  and  means  for  meeting  part  of  the  debt  of  the  United 
States  to  England,  without  shipping  any  more  American  gold. 
This  could  only  be  done  by  England's  giving  America  some 
sort  of  credit  to  take  the  place  of  the  finance  bills  and  other 


822  EUROPEAN  WAR 

forms  of  accommodation  which  Lombard  Street  had  with- 
drawn. 

At  the  same  time  there  is  no  doubt  that  New  York  did  some 
of  the  business  for  herself  that  London  had  formerly  done 
for  her.  If  she  was  not  in  a  position  to  finance  other  coun- 
tries, she  did  make  a  beginning  in  financing  her  own  imports. 
Exporters  of  goods  from  South  America  to  the  United  States 
who  had  formerly  taken  payment  by  drawing  bills  on  London, 
and  were  no  longer  able  to  do  so,  drew  on  financial  institutions 
in  New  York  instead.  Some  of  these  bills  were  used  to  make 
three-cornered  payments  from  South  America  to  London,  and 
a  very  costly  means  of  payment  they  were  to  the  debtor, 
owing  to  the  high  rate  of  discount  in  New  York,,  and  the  de- 
preciation of  the  American  dollar  as  compared  with  the  pound 
sterling.  .  .  . 

It  seems  likely  that  this  business  of  financing  American 
trade  New  York  will  keep  in  her  own  hands  to  a  greater 
extent  than  she  did  before.  Probably  she  would  have  taken 
more  of  it  to  herself  even  if  there  had  been  no  war.  Her  new 
banking  legislation  has  included  in  its  aim  the  establishment 
of  branches  of  American  banks  abroad,  and  the  development 
of  acceptance  business  in  New  York.  It  could  not  be  ex- 
pected that  New  York  would  always  be  content  to  see  the 
greater  part  of  America's  external  trade  financed  with  Eng- 
lish credit.  Her  next  step  will  be  to  endeavor  to  finance 
other  people's  trade,  and  she  is  already  beginning  to  set  about 
taking  it,  being  assisted  by  Lombard  Street's  shyness  in  the 
matter  of  new  acceptance  business.  If  the  war  should  be  long 
continued,  its  appalling  drain  on  the  combatants  ought  to  help 
her  by  exhausting  the  rivals  whom  she  hopes  to  drive  out  of 
the  field. 

So  far,  then,  from  the  late  crisis  having  given  any  evidence 
of  weakness  on  the  part  of  London,  or  of  any  likelihood  that 
she  will  lose  her  supremacy  as  the  world's  banker,  the  com- 
manding strength  of  her  position  has  been  made  abundantly 
manifest.  The  only  weak  point  was  not  in  her  armor  but 
in  that  of  her  foreign  customers.  The  question  arises  whether 
she  was  wise  in  lending  so  much  to  debtors  who  showed  such 
unanimous  inability  to  pay  on  the  due  dates.  I  have  heard  it 


THE  WORLD'S  FINANCIAL  CENTER  823 

contended  by  a  disinterested  and  well-qualified  critic,  that  the 
risk  run  by  Lombard  Street  in  allowing  bills  to  be  drawn  on 
her  from  all  parts  of  the  world  against  goods  shipped  from 
one  country  to  another,  has  been  shown  by  the  late  crisis  to  be 
too  great  to  be  worth  the  candle.  Bills  drawn  against  goods 
coming  to  England  are  safe  enough,  for  as  long  as  the  goods 
come  to  port  and  can  be  sold  for  them,  the  acceptor  is  sure 
of  his  money.  But  when  the  goods  go  from  China  to  Peru, 
and  Peru  finds  that  it  cannot  remit  to  meet  the  bill,  the  ac- 
ceptor is  inconvenienced,  and  the  bank  or  bill  broker  who  holds 
the  bill  finds  that  he  has  got  a  security  which  was  not  quite  as 
gilt-edged  as  he  thought  it.  This  is  all  quite  true,  but  con- 
trariwise it  may  be  argued  that  this  sort  of.  world  crisis  is  not 
going  to  happen  again  very  soon,  and  that  if  all  finance  had 
to  be  arranged  on  the  theory  that  it  was  likely  to  recur  fre- 
quently, there  would  be  very  little  finance  of  any  kind.  These 
bills  drawn  against  international  shipments  of  goods  do  much 
to  make  the  bill  on  London  popular  all  over  the  world,  and  if 
they  are  to  be  frowned  on  there  will  be  a  considerable  restric- 
tion of  international  commerce,  which  will  react  unpleasantly 
on  England.  In  ordinary  times  these  bills  are  safe  enough, 
if  due  precautions  are  taken.  If  mistakes  are  made  they  hap- 
pen rarely  and  the  resources  of  the  accepting  houses  are  easily 
able  to  repair  the  damage. 

As  to  finance  bills,  it  has  already  been  admitted  that  much 
credit  was  given  by  their  means  which  was  used  for  purposes 
with  which  bills  of  exchange  ought  not  to  be  associated.  The 
essence  of  a  bill  of  exchange  is  that  it  has  to  be  met  at  its  due 
date,  and  so  it  should  only  be  drawn  to  finance  some  com- 
mercial operation  that  will  mature  before  the  bill  falls  due,  or 
to  provide  means  of  remittance  when  they  are  scarce,  owing 
to  seasonal  causes  which  will  have  passed  before  the  bill's 
maturity.  When  rolling  credits,  as  they  are  called,  are  estab- 
lished, which  go  on  from  year  to  year,  each  bill  being  met  by 
drawing  another,  and  the  money  so  raised  in  the  borrowing 
country  is  put  into  bricks  and  mortar  or  machinery  or  other 
forms  of  fixed  capital,  the  uses  of  the  bill  of  exchange  are 
being  strained.  When  a  jolt  comes  to  the  machinery  and  the 
rolling  credit  stops  rolling,  it  is  not  possible  to  sell  the  factory 


824  EUROPEAN  WAR 

or  plant  to  provide  a  means  of  remittance.  But  there  is  no 
doubt  that  for  a  time,  at  least,  this  kind  of  finance  bill  is  likely 
to  be  scarcer  than  it  was ;  in  fact,  as  we  have  seen,  it  was  the 
excessive  suddenness  of  the  fit  of  virtue  that  seized  Lombard 
Street  on  this  subject  that  made  the  crisis  more  acute  than  it 
need  have  been,  by  reducing  the  means  of  remittance  and  so 
keeping  the  exchanges  at  an  abnormal  point. 

Lombard  Street  has  thus  shown  that  it  has  fully  learnt  the 
only  lesson  that  the  external  side  of  the  crisis  had  to  teach  it. 
Too  many  finance  bills  of  the  wrong  kind  were  out,  and  Lom- 
bard Street  saw  the  fact  so  clearly  that  for  some  weeks  it  rang 
with  the  cry  that  there  must  never  be  any  more  finance  bills 
of  any  kind  at  all.  This  exaggerated  view  is  already  dis- 
credited, and  there  is  good  reason  to  hope  that  opinion  will 
settle  down  to  a  sensible  midway  path,  taking  -the  finance  bill 
as  a  quite  legitimate  and  necessary  convenience,  dangerous 
only  when  abused  and  distorted.  .  .  . 

MR.    WITHERS   A   GOOD   ENGLISHMAN 

1  Mr.  Withers  is  a  very  good  Englishman  indeed  and  points 
out  with  pardonable  pride  how  the  London  market  stood  the 
shock  which  rocked  the  rest  of  the  financial  world  to  its  very 
foundations.  What  would  have  been  his  attitude  had  the 
book  been  written  a  little  later,  however,  when  the  pound 
sterling  had  fallen  to  a  discount  of  over  2  per  cent,  as  com- 
pared with  the  dollar,  is  an  interesting  subject  of  speculation. 
London  financing  the  world  is,  from  the  Englishman's  point 
of  view,  an  inspiring  sight,  but  the  pound  sterling  obtainable 
in  New  York  for  $4.76  .  .  .  is  something  which  it  would  be 
interesting  to  hear  Mr.  Withers  explain.  War  and  Lombard 
Street  treats  only  with  the  beginning  of  a  very  big  subject.  It 
is  sincerely  to  be  hoped  that  a  little  later  we  shall  have  a  con- 
tinuation of  the  work  from  Mr.  Withers'  pen. 

AMERICA'S  CHANCE  OF  HOLDING  WORLD  PURSE-STRINGS  2 
Since  the  outbreak  of  the  war  New  York  has  assumed  a 

1  Franklin  Escher,  Review  of  War  and  Lombard  Street,  The  American 
Economic  Review,  Vol.  5,  No.  3,  September,  1915,  pp.  624-5. 

2  E.  W.  Kemmerer,  America's  Chance  of  Holding  World  Purse-Strings. 
The  Annalist,  Vol.  7,  No.  158,  Jan.  24,  1916,  pp.  119-121,  144. 


THE  WORLD'S  FINANCIAL  CENTER  825 

position  of  leadership  in  international  banking.  Will  this 
position  be  permanent  or  will  its  duration  be  limited  practically 
to  the  period  of  the  war?  Is  the  mantle  of  world  financial 
leadership  about  to  pass  from  London  to  New  York,  as  it 
passed  after  the  Napoleonic  Wars  from  Amsterdam  to  Lon- 
don ?  These  are  questions  which  many  are  asking,  but  which 
no  one  can  answer  positively,  because  so  much  depends  upon 
those  incalculable  items  —  the  duration  of  the  war  and  the 
financial  strength  of  the  belligerents  at  its  close.  .  .  . 

At  the  end  of  1913  our  provincial  banking  system  was  over- 
hauled by  the  Federal  Reserve  Act,  and  put  in  shape  to  meet 
the  needs  of  our  growing  trade,  both  domestic  and  foreign. 
By  this  act  American  commercial  paper,  which  previously  had 
been  essentially  local  paper,  was  given  an  opportunity  to  as- 
sume a  national,  or  even  international,  character,  through  the 
provisions  for  bank  acceptances,  rediscount,  and  "  open  mar- 
ket operations."  An  open  discount  market  began  to  develop 
on  American  soil;  and  slowly,  but  surely,  short-time  paper  of 
an  international  character  and  standing  began  to  appear.  .  .  . 

By  the  beginning  of  1914,  therefore,  it  may  be  said,  that  the 
way  was  opened  for  our  financial  metropolis,  New  York,  to 
play  an  increasingly  important  role  in  the  international  money 
market,  and  that  there  was  already  a  movement  in  that  direc- 
tion. 

To  this  movement  the  European  war  gave  a  strong  impetus, 
and  to-day  New  York  clearly  holds  the  premier  position  in  the 
field  of  international  finance,  although  at  a  time  when  national 
finance  in  the  leading  countries  of  Europe  has  assumed  pro- 
portions never  before  dreamed  of.  The  European  exchange 
markets  have  been  demoralized,  and  specie  payments  among 
the  belligerent  countries  of  Europe  have  become  little  more 
than  a  name.  On  the  other  hand,  "  dollar  exchange  "  is  now 
quoted  in  the  principal  cities  of  Latin  America,  the  Orient, 
and  Australia;  and  the  American  trade  with  those  sections, 
which  was  formerly  financed  chiefly  through  London,  ij  now 
being  financed  directly,  and  in  dollars.  .  .  . 

The  United  States  has  brought  back  home  from  a  billion 
to  two  billion  dollars'  worth  of  the  six  billion  dollars'  worth  of 
its  securities  estimated  to  have  been  held  abroad,  and  is  pre- 


826  EUROPEAN  WAR 

paring  to  take  more,  either  by  purchase  or  as  security  for 
loans.  It  has  loaned  upwards  of  a  billion  dollars  to  the  bel- 
ligerent countries,  and  has  had  a  net  importation  of  gold 
during  the  year  just  closed  greater  than  that  of  any  five  years 
of  its  history.  Our  banks  are  carrying  heavy  surplus  reserves, 
those  of  the  New  York  Clearing  House  banks  alone  on  Decem- 
ber 31  having  amounted  to  $143,000,000,  and  the  gold  reserve 
against  net  liabilities  of  the  twelve  federal  reserve  banks  on 
December  23  haying  amounted  to  86  per  cent. ;  and  this,  at  a 
time  when  the  large  gold  reserves  of  the  European  banks  are 
strained  to  the  breaking  point  by  the  tremendous  liabilities 
placed  upon  them, 

Our  export  trade  has  reached  unprecedented  heights,  and 
for  the  year  1915  was  approximately  equal  to  twice  that  of 
1906.  .  .  . 

This  war  is  likely  to  leave  her  [England]  still  with  a  secure 
position,  a  great  and  loyal  colonial  empire,  an  efficient  banking 
system,  and  the  control  of  the  seas.  Her  position  as  a  creditor 
nation  will  be  greatly  weakened,  and  she  may  even  become  a 
heavy  debtor  nation,  but  her  foreign  trade  connections  have 
been  so  long  and  so  well  established  that  it  does  not  seem  likely 
that  they  will  be  permanently  impaired  in  any  large  degree 
by  the  readjustments  necessitated  by  the  war.  If  she  disposes 
of  her  Latin- American  and  Asiatic  investments  to  the  United 
States  she  will  doubtless  greatly  weaken  her  trade  position  in 
those  countries,  but  the  present  evidence  is  that  these  will  be 
about  the  last  foreign  investments  she  will  dispose  of. 

So  far  we  have  not  made  great  progress  in  securing  Eu- 
rope's Latin-American  trade.  Europe  discontinued  financing 
Latin  America  at  the  same  time  that  she  discontinued  her 
normal  trading  with  Latin  America.  For  us  to  take  her  place 
it  became  necessary  for  us  to  loan  before  we  could  sell  and 
buy.  But  loaning  to  European  belligerents  and  selling  war 
supplies  offered  larger  immediate  profits ;  and  so  our  chief 
efforts  have  been  turned  eastward  rather  than  southward.  An 
analysis  of  our  large  export  trade  of  last  year  shows  that 
much  of  it  was  of  a  very  abnormal  character,  and  gives  prom- 
ise of  being  but  temporary.  .  The  following  figures  comparing 
the  exports  of  a  few  selected  commodities  for  the  ten  months 


THE  WORLD'S  FINANCIAL  CENTER  827 

ended  October,  1915,  with  those  for  the  same  period  of  1914 
will  make  this  point  clear : 

Ten  Months  Ended  Oct.  jj, 
Commodities.  1914-  19-15- 

Breadstuffs     •„ $212,025,814  $461,074,547 

Iron  and  steel  and  mfrs.  thereof,  incl.  wire 169,232,270    294,822,223 

Meat    products     110,180,785     214,212,955 

Animals  (notably  horses  and  mules)    6,668,121     107,201,175 

Explosives    6439,693     103,527,382 

Cars,  carriages,  etc 36,844,923     1 17,366,359 

Leather  and  mfrs.  thereof   47,123,910     135,847,788 

A  glance  at  these  articles  will  show  that  most  of  them  were 
intended  chiefly  for  military  uses,  and  that  their  heavy  ex- 
portation presumably  will  be  but  temporary. 

It  is  interesting  to  note  that  some  other  articles  of  customary 
export  showed  large  declines  in  1915  as  compared  with  1914. 
During  the  same  ten  months'  period,  for  example,  our  exports 
of  agricultural  implements  (and  parts)  declined  from  $21,- 
028,588  in  1914  to  $11,162,609  m  I9I55  °f  wood  and  manu- 
factures thereof,  from  $68,904,895  to  $45,325,146;  of  fer- 
tilizers, from  $7,735,613  to  $3,758,598;  and  of  sewing  ma- 
chines, from  $7,757,421  to  $4,902,594. 

Viewed  from  the  standpoint  of  the  destination  of  the  articles 
exported,  the  significant  fact  is  that  the  increase  in  exports  was 
chiefly  to  Europe,  and  not  to  Central  and  South  America  and 
Asia  —  the  places  in  which  we  have  been  strenuously  en- 
deavoring in  recent  years  to  build  up  a  permanent  export 
trade.  .  .  . 

.  .  .  After  the  war  is  over  Europe  will  presumably  discon- 
tinue, or  greatly  reduce,  her  importations  from  the  United 
States  of  most  of  the  articles  which  figured  so  largely  in  the 
great  increase  of  1915.  As  her  needs  tend  to  become  normal 
again  she  will  immediately  endeavor  to  resume  her  old-time 
trade  connections,  both  import  and  export,  at  least  in  so  far  as 
the  trading  centres  are  in  countries  that  were  friendly  or  neu- 
tral during  the  war.  In  seeking  to  re-establish  these  connec- 
tions the  merchants  of  the  belligerent  countries  will  be  strongly 
backed  by  their  Governments,  which  the  war  will  have  made 
more  socialistic  and  more  aggressive.  They  will  have  a  great 
advantage  in  the  fact  of  long-established  business  relations, 
and  in  the  fact  that  the  war  trade  will  have  been  to  such  a 


828  EUROPEAN  WAR 

large  extent  abnormal,  both  as  regards  the  products  dealt  in 
and  the  parties  to  the  trade. 

Europe's  banking  machinery  in  South  and  Central  America, 
although  it  may  not  be  very  actively  functioning  in  these  try- 
ing times,  still  exists,  and  will  be  ready  to  resume  its  former 
activities  as  soon  as  peace  is  declared.  .  .  . 

On  the  basis  of  London  Stock  Exchange  listings  British  in- 
vestments in  Latin  America  early  in  1914  were  computed  at 
nearly  $6,000,000,000.  Germany  also  has  a  large  number  of 
banking  establishments  in  South  America  and  heavy  invest- 
ments. .  .  .  United  States  investments  in  South  America  are 
very  small  as  compared  with  those  of  England  and  Germany, 
while  only  one  American  bank  has  established  branches  on 
that  continent.  These  branches  are  only  five  in  number,  and 
the  oldest  of  them  is  but  a  little  over  a  year  old. 

The  conclusion  seems  clear  that  the  war  will  need  to  be  very 
long  and  very  disastrous  to  England ;  and  American  merchants, 
bankers,  and  investors  will  need  to  be  much  more  active  and 
far-sighted  in  their  exploitation  of  South  American  oppor- 
tunities than  they  have  been  in  the  past,  if  London  is  to  yield 
to  New  York  her  financial  premiership  for  South  America. 

Other  obstacles  to  New  York's  becoming  permanently  the 
world's  financial  centre  are  its  great  distance  from  the  financial 
markets  of  Europe,  America's  small  merchant  marine,  its 
provincial  protective  tariff  policy,  the  absence  of  an  adequate 
supply  of  men  possessing  the  necessary  training  both  in  for- 
eign languages  and  in  commerce  and  international  finance  to 
go  into  these  foreign  fields  and  to  "  tie  them  up  "  commer- 
cially and  financially  with  the  United  States,  and  the  slowness 
with  which  our  recently  reorganized  banking  system  and  our 
American  discount  market  must  grow,  as  regards  international 
business,  if  it  is  to  have  root?  that  are  strong  and  grow  deep. 

The  United  States  has  before  it  a  great  opportunity.  Much 
depends  upon  the  foresight  w.'th  which  Americans  prepare 
themselves  to  meet  the  tremendous  readjustments  that  will  be 
demanded  at  the  close  of  the  war.  That  will  be  the  supreme 
test.  Now  is  the  time  to  build  for  the  future,  and  to  avoid 
paying  too  much  attention  to  immediate  profits.  New  York 
can  hardly  be  expected  to  succeed  to  London's  position  as  the 


THE  WORLD'S  FINANCIAL  CENTER  829 

world's  financial  centre,  at  least  for  some  time  to  come;  dollar 
exchange  will  not  at  once  take  permanent  rank  ahead  of 
sterling,  or  even  alongside  it;  none  the  less,  if  the  United 
States  refuses  to  be  blinded  by  the  glamor  of  large  immedi 
ate  profits  from  a  type  of  trade  that  is  necessarily  abnormal 
and  temporary,  and  if  she  seriously  turns  her  attention  to  the 
opportunities  now  open  to  her  in  Latin  America,  she  will  make 
a  long  step  forward  in  the  direction  of  financial  leadership. 


APPENDIX  A 

AN   APPROXIMATE   FORMULA   FOR   DETERMINING  THE 
VELOCITY  OF  THE  CIRCULATION  OF  MONEY 

1  For  the  purpose  of  tracing  the  circulation  of  money,  and  measur- 
ing it  by  bank  records,2  we  may  classify  the  persons  who  use  money 
in  purchase  of  goods  into  three  groups: 

1.  Commercial  depositors,  i.  e.,  all  engaged  in  business  —  firms,  com- 
panies, and  others  —  who  have  bank  deposits  mainly  or  wholly  apart 
from  personal  accounts. 

2.  All  other  depositors,  chiefly  private  persons. 

3.  All  who,  like  most  wage  earners,  are  not  depositors  at  all. 

These  three  classes  we  shall  distinguish  as  "  Commercial  deposit- 
ors," "  Other  depositors,"  and  "Nondepositors,"  or  C,  O,  and  N. 
The  money  in  the  possession  of  "  Commercial  depositors  "  we  shall 
call  "  till  money,"  and  the  rest  "  pocket  money." 

The  three  groups  necessarily  include  all  in  the  community  who  cir- 
culate money.  By  circulating  money  is  meant  expending  it  in  ex- 
change, not  for  some  other  circulating  medium,  as  checks,  but  for 
goods.  .  .  . 

.  .  .  The  category  of  "  commercial  depositors "  coincides  for  all 
practical  purposes  with  the  category  of  business  establishments. 

"  Other  depositors  "  include  most  proprietors,  professional,  and  sal- 
aried persons.  Almost  no  wage  earners  are  included,  and  almost  no 
business  establishments  or  business  men  in  a  business  capacity.  .  .  . 

.  .  .  Although  "  other  depositors "  include  most  proprietors  and 
professional  and  salaried  persons,  yet  some  proprietors  and  profes- 
sional men,  especially  in  rural  communities,  and  some  salaried  persons, 
chiefly  small  clerks,  are  "  Nondepositors."  .  .  . 

..."  Nondepositors  "  consist  chiefly  of  those  who  are  classed  in 
statistics  as  wage  earners.  While  there  are  some  wage  earners  who 
are  depositors,3  they  are  rare :  and  while  there  are  some  "  nonde- 
positors  "  who  are  not  wage  earners,  especially  (as  just  indicated) 

1  Irving  Fisher,  Purchasing  Power  of  Money,  Appendix  XII,  pp.  448-454. 
The  Macmillan  Company.     New  York.     1911. 

2  For  a  complete  formula  for  determining  the  velocity  of  the  circulation 
of  money  see  pages  448-460,  of  the  Purchasing  Power  of  Money. 

s  The  term  "  depositors,"  as  here  used,  does  not,  of  course,  include  sav- 
ings bank  depositors.  A  savings  bank  is  not  a  true  bank  of  deposit,  pro- 
viding circulating  credit. 

830 


APPENDICES 


831 


the  agricultural  proprietors  (farmers)  and  small  clerks,  the  amount 
of  money  circulated  by  them  is  small  in  comparison  with  the  total 
circulation.  While  the  line  separating  wages  and  salaries  is  not 
definitely  marked  in  theory,  it  is  usually  easily  recognised  in  prac- 
tice. .  .  . 

We  may  now  picture  concretely  the  main  currents  of  the  monetary 
flow,  including  the  circulation  of  money  in  exchange  for  goods.  .  .  . 
[The  figure  here  given]  illustrates  the  three  principal,  types. 


The  corners  of  the  triangle,  C,  O,  and  N,  represent  the  three 
groups  of  "  commercial  depositors,"  "  other  depositors,"  and  "non- 
depositors,"  and  the  B's  represent  banks.  The  arrows  represent  the 
flow  of  money  from  each  of  these  four  categories  to  the  others.  Thus 
B0  represents  the  annual  withdrawals  from  banks  by  "  other  de- 
positors," Oc  the  spending  of  this  withdrawn  money  by  "  other  de- 
positors "  among  "  commercial  depositors,"  and  Cb  the  return  of  the 
money  from  the  "  commercial  depositors  "  to  the  banks.  This  circuit 
(B0  Oc  Cb)  of  three  links  is  very  common.  A  second  type  of  circuit 
is  represented  by  a  chain  of  four  arrows  (B0OnNcCb).  It  is  illus- 
trated by  private  depositors  drawing  money  (B0),  and  paying  wages 
(On)  to  servants  who  in  turn  spend  the  money  (Nc)  among  trades- 
men who  finally  deposit  it  (Cb).  A  third  type  of  circuit,  also  four- 
fold, is  represented  by  the  arrows  Bc  Cn  Nc  Cb.  It  is  illustrated  by 
commercial  firms  cashing  their  checks  at  banks  (Bc)  for  pay  rolls, 
with  the  cash  so  obtained  paying  wages  (Cn)  to  workmen  who  spend 


832  APPENDICES 

it  (Nc)  among  other  tradesmen  who  redeposit  it  in  banks  (Cb). 
These  three  types  are  not  the  only  ones,  but  they  are  so  much  more 
important  than  any  others  that  they  merit  our  undivided  attention 
before  a  completer  study  is  undertaken.  .  .  .  [The  accompanying 
figure]  has  been  constructed  for  the  purpose  of  exhibiting  them  un- 
complicated by  other  details. 

It  will  be  noted  that  not  all  of  the  flows  described  are  examples  of 
the  circulation  of  money.  As  already  indicated,  money  may  be  said 
to  circulate  only  when  it  passes  in  exchange  for  goods.  Its  entrance 
into  and  exit  from  banks  is  a  flow,  but  not  a  circulation  against  goods. 
In  the  diagram  the  horizontal  arrows  represent  such  mere  banking 
operations,  not  true  circulation.  On  the  other  hand,  the  arrows  along 
the  sides  of  the  triangle  represent  actual  circulation.  The  diagram 
shows  four  such  arrows,  representing  the  four  chief  types  of  circula- 
tion: Oc  payments  of  money  from  "other  depositors"  to  "commer- 
cial depositors  "  in  the  purchase  of  goods ;  On  payments  from  "  other 
depositors"  to  "  nondepositors,"  as  when  a  housewife  pays  wages;  Cn 
payments  from  "  commercial  depositors "  to  "  nondepositors."  as 
when  a  firm  pays  wages ;  and  Nc  payments  from  "  nondepositors  "  to 
"commercial  depositors,"  as  when  a  wage  earner  buys  goods  of  a  mer- 
chant. 

These  four  types  of  circulation  of  money  occur  in  the  three  cir- 
cuits already  described,  being  sandwiched  between  the  flows  from 
and  to  the  banks.  The  first,  Oc,  is  contained  within  the  circuit 
B0  Oc  Cb  and,  since  no  "  nondepositors  "  intervene,  represents  money 
changing  hands  once  between  its  withdrawal  from  bank  and  its  re- 
deposit  there.  The  remaining  types  (Oa,  Cn,  and  Ne)  are  contained 
within  the  two  other  circuits  (B0  On  Nc  Cb  and  Bc  Cn  Nc  Cb),  and, 
owing  to  the  fact  that  "  nondepositors  "  intervene,  represent  money 
circulating  twice  between  withdrawal  and  redeposit. 

In  short,  one  of  the  three  circuits  (B0OcCb)  shows  money  circu- 
lating once  out  of  bank.  Both  the  others  pass  through  N,  and  show 
money  circulating  twice  out  of  bank.  The  diagram,  then,  represents 
all  circulating  money  as  springing  from  and  returning  to  the  banks; 
all  of  it  as  circulating  at  least  once  in  the  interim ;  and  that  portion 
handled  by  "  nondepositors  "  as  circulating  once  in  addition.  There- 
fore, the  total  circulation  exceeds  the  total  flow  from  and  to  banks 
by  the  amount  flowing  through  "  nondepositors."  In  other  words,  the 
total  circulation  in  the  diagram  is  simply  the  sum  of  the  annual  money 
flowing  from  and  to  banks  and  the  money  handled  by  "  nondepositors." 
The  quotient  of  this  sum  divided  by  the  amount  of  money  in  circula- 
tion will  give  approximately  the  velocity  of  circulation  of  money.  .  .  . 


APPENDIX  B   . 

SOME   REGULATIONS   OF   THE   FEDERAL   RESERVE 

BOARD 

FEDERAL  RESERVE  BOARD 

WASHINGTON,  January  12,  1915. 

ACCEPTANCE  OF  STATEMENTS  IN  LIEU  OF  CERTIFICATES  AS  TO  CHARACTER 
OF   COMMERCIAL   PAPER 

Whenever  a  member  bank  shall  offer  for  rediscount  any  note,  draft, 
or  bill  of  exchange  bearing  the  indorsement  of  such  member  bank, 
with  waiver  of  demand  notice  and  protest,  the  directors  or  executive 
committee  of  the  federal  reserve  bank  may,  until  July  15,  1915,  accept 
as  evidence  that  the  proceeds  of  such  note,  draft,  or  bill  of  exchange 
were  or  are  to  be  used  for  agricultural,  industrial,  or  commercial 
purposes  (and  that  such  notes,  drafts,  or  bills  of  exchange  in  other 
respects  comply  with  the  regulations  of  the  board),  a  written  state- 
ment from  the  officer  of  the  applying  bank  that  of  his  own  knowledge 
and  belief  the  original  loan  was  made  for  one  of  the  purposes  men- 
tioned, and  that  the  provisions  of  the  act  and  regulations  issued  by 
the  board  have  been  complied  with. 

CHARLES  S.  HAMLIN, 

Governor. 
H.  PARKER  WILLIS, 

Secretary. 

FEDERAL  RESERVE  BOARD 

WASHINGTON,  April  2,  1915. 
BANKERS'  ACCEPTANCES 

I 

DEFINITION 

In  this  regulation  the  term  "  acceptance  "  is  defined  as  a  draft  or 
bill  of  exchange  drawn  to  order,  having  a  definite  maturity,  and  pay- 
able in  dollars,  in  the  United  States,  the  obligation  to  pay  which  has 
been  accepted  by  an  acknowledgment  written  or  stamped  and  signed 
across  the  face  of  the  instrument  by  the  party  on  whom  it  is  drawn ; 
such  agreement  to  be  to  the  effect  that  the  acceptor  will  pay  at 

833 


834  APPENDICES 

maturity  according  to  the  tenor  of  such  draft  or  bill  without  qualify- 
ing conditions. 

II 

STATUTORY   REQUIREMENTS    UNDER   SECTIONS    13    AND    14 

Section  13  of  the  Federal  Reserve  Act  as  amended  provides  that : 

(a)  Any  federal  reserve  bank  may  discount  acceptances: 

(1)  Which  are  based  on  the  importation  or  exportation  of 

goods ; 

(2)  Which  have  a  maturity  at  time  of  discount  of  not  more 

than  three  months;  and 

(3)  Which  are  indorsed  by  at  least  one  member  bank. 

(b)  The  amount  of  acceptances  so  discounted  shall  at  no  time  ex- 

ceed one-half  the  paid-up  capital  stock  and  surplus  of  the 
bank  for  which  the  rediscounts  are  made,  except  by  au- 
thority of  the  Federal  Reserve  Board  and  of  such  general 
regulations  as  said  board  may  prescribe,  but  not  to  exceed 
the  capital  stock  and  surplus  of  such  bank. 

(c)  The  aggregate  of  notes  and  bills  bearing  the  signature  or 

indorsement  of  any  one  person,  company,  firm,  or  cor- 
poration rediscounted  for  any  one  bank  shall  at  no  time 
exceed  10  per  centum  of  the  unimpaired  capital  and  surplus 
of  said  bank;  but  this  restriction  shall  not  apply  to  the 
discount  of  bills  of  exchange  drawn  in  good  faith  against 
actually  existing  values. 

Section  14  of  the  Federal  Reserve  Act  permits  federal  reserve  banks, 
under  regulations  to  be  prescribed  by  the  Federal  Reserve  Board,  to 
purchase  and  sell  in  the  open  market  bankers'  acceptances,  with  or 
without  the  indorsement  of  a  member  bank. 

Ill 

RULING 

The  Federal  Reserve  Board,  exercising  its  power  of  regulation 
with  reference  to  paragraph  II  (b)  hereof,  rules  as  follows: 

Any  federal  reserve  bank  shall  be  permitted  to  discount  for  any 
member  bank  "  bankers'  acceptances  "  as  hereinafter  defined  up  to  an 
amount  not  to  exceed  the  capital  stock  and  surplus  of  the  bank  for 
which  the  rediscounts  are  made. 

IV 

ELIGIBILITY 

The  Federal  Reserve  Board  has  determined  that,  until  further 
order,  to  be  eligible  for  discount  under  section  13,  by  federal  reserve 
banks,  at  the  rates  to  be  established  for  bankers'  acceptances: 


APPENDICES  835 

(a)  Acceptances  must  comply  with  the  provisions  of  paragraph 

II  (a),   (b),  (c)  hereof; 

(b)  Acceptances  must  have  been  made  by  a  member  bank,  non- 

member  bank,  trust  company,  or  by  some  private  banking 
firm,  person,  company,  or  corporation  engaged  in  the  busi- 
ness of  accepting  or  discounting.  Such  acceptances  will 
hereafter  be  referred  to  as  "  bankers'  "  acceptances ;  x 

(c)  A  banker's  acceptance  must  be  drawn  by  a  commercial,  in- 

dustrial, or  agricultural  concern  (that  is,  some  person, 
firm,  company,  or  corporation)  directly  connected  with 
the  importation  or  exportation  of  the  goods  involved  in  the 
transaction  in  which  the  acceptance  originated,  or  by  a 
"  banker."  In  the  latter  case  the  goods,  the  importation 
or  exportation  of  which  is  to  be  financed  by  the  accept- 
ance, must  be  clearly  specified  in  the  agreement  with  or 
the  letter  of  advice  to  the  acceptor.  The  bill  must  not  be 
drawn  or  renewed  after  the  goods  have  been  surrendered 
to  the  purchaser  or  consignee. 

(d)  A  banker's  acceptance  must  bear  on  its  face  or  be  accom- 

panied by  evidence  in  form  satisfactory  to  a  federal  re- 
serve bank  that  it  originated  in  an  actual  bona  fide  sale  or 
consignment  involving  the  importation  or  exportation  of 
goods.  Such  evidence  may  consist  of  a  certificate  on  or 
accompanying  the  acceptance  to  the  following  effect: 
.  This  acceptance  is  based  upon  a  transaction  involving  the 

importation  or  exportation  of  goods.    Reference  No.  . 

Name  of  acceptor . 

(e)  Bankers'   acceptances,  other  than  those  of  member  banks, 

shall  be  eligible  only  after  the  acceptors  shall  have  agreed 
in  writing  to  furnish  to  the  federal  reserve  banks  of  their 
respective  districts,  upon  request,  information  concerning 
the  nature  of  the  transactions  against  which  acceptances 
(certified  or  bearing  evidence  under  IV  (d)  hereof)  have 
been  made. 

(f)  A  bill  of  exchange  accepted  by  a  "banker"  may  be  con- 

sidered as  drawn  in  good  faith  against  "  actually  existing 
values,"  under  II  (c)  hereof,  when  the  acceptor  is  secured 
by  a  lien  on  or  by  transfer  of  title  to  the  goods  to  be 
transported ;  or,  in  case  of  release  of  the  goods  before  pay- 
ment of  the  acceptance,  by  the  substitution  of  other  ade- 
quate security; 

(g)  Except  in  so  far  as  they  may  be  secured  by  a  lien  on  or  by 

transfer  of  the  title  to  the  goods  to  be  transported,  as 
under  (f),  the  bills  of  any  person,  firm,  company,  or  cor- 

i  Drafts  and  bills  of  exchange  eligible  for  rediscount  under  section  13, 
other  than  "  bankers' "  acceptances,  have  been  dealt  with  by  Regulation  B, 
series  of  1915. 


836  APPENDICES 

poration,  drawn  on  and  accepted  by  any  private  banking 
firm,  person,  company,  or  corporation  (other  than  a  bank 
or  trust  company)  engaged  in  the  business  of  discounting 
and  accepting,  and  discounted  by  a  federal  reserve  bank, 
shall  at  no  time  exceed  in  the  aggregate  a  sum  equal  to 
5  per  centum  of  the  paid-in  capital  of  such  federal  re- 
serve bank; 

(h)  The  aggregate  of  acceptances  of  any  private  banking  firm, 
person,  company,  or  corporation    (other  than  a  bank  or 
trust  company)  engaged  in  the  business  of  discounting  or 
accepting,  discounted  or  purchased  by  a  federal  reserve 
bank,  shall  at  no  time  exceed  a  sum  equal  to  25  per  centum 
of  the  paid-in  capital  of  such  federal  reserve  bank. 
To  be  eligible  for  purchase  by  federal  reserve  banks  under  section 
14,  bankers'  acceptances  must  comply  with  all  requirements  and  be 
subject  to  all  limitations  hereinbefore  stated,  except  that  they  need 
not  be  indorsed  by  a  member  bank :     Provided,  however,  That  no 
federal  reserve  bank  shall  purchase  the  acceptance,  of  a  "  banker  " 
other  than  a  member  bank  which  does  not  bear  the  indorsement  of 
a  member  bank,  unless  a  federal  reserve  bank  has  first  secured  a  satis- 
factory statement  of  the  financial  condition  of  the  acceptor  in  form 
to  be  approved  by  the  Federal  Reserve  Board. 

V 

POLICY   AS   TO   PURCHASES 

While  it  would  appear  impracticable  to  fix  a  maximum  sum  or 
percentage  up  to  which  federal  reserve  banks  may  invest  in  bankers' 
acceptances,  both  under  section  13  and  section  14,  it  will  be  necessary 
to  watch  carefully  the  aggregate  amount  to  be  held  from  time  to 
time.  In  framing  their  policy  with  respect  to  transactions  in  accept- 
ances, federal  reserve  banks  will  have  to  consider  not  only  the  local 
demands  to  be  expected  from  their  own  members,  but  also  require- 
ments to  be  met  in  other  districts.  The  plan  to  be  followed  must  in 
each  case  adapt  itself  to  the  constantly  varying  needs  of  the  country. 

CHARLES  S.  HAMLIN, 

Governor. 
H.  PARKER  WILLIS, 

Secretary. 

FEDERAL  RESERVE  BOARD 

WASHINGTON,  April  2,  1915. 

ACCEPTANCE   BY    MEMBER   BANKS 

By  act  of  Congress  approved  March  3,  1915,  section  13  (paragraphs 
3,  4,  and  5  of  the  Federal  Reserve  Act)  was  amended  and  re-enacted 
so  as  to  read  as  follows : 

Any   federal   reserve   bank   may  discount  acceptances   which   are 


APPENDICES  837 

based  on  the  importation  or  exportation  of  goods  and  which  have  a 
maturity  at  time  of  discount  of  not  more  than  three  months  and 
indorsed  by  at  least  one  member  bank.  The  amount  of  acceptancer 
so  discounted  shall  at  no  time  exceed  one-half  the  paid-up  and  un- 
impaired capital  stock  and  surplus  of  the  bank  for  which  the  redis- 
counts are  made,  except  by  authority  of  the  Federal  Reserve  Board, 
under  such  general  regulations  as  said  board  may  prescribe,  but  not 
to  exceed  the  capital  stock  and  surplus  of  such  bank. 

The  aggregate  of  such  notes  and  bills  bearing  the  signature  or  in- 
dorsement of  any  one  person,  company,  firm,  or  corporation  redis- 
counted  for  any  one  bank  shall  at  no  time  exceed  10  per  centum  of 
the  unimpaired  capital  and  surplus  of  said  bank;  but  this  restriction 
shall  not  apply  to  the  discount  of  bills  of  exchange  drawn  in  good 
faith  against  actually  existing  values. 

Any  member  bank  may  accept  drafts  or  bills  of  exchange  drawn 
upon  it  and  growing  out  of  transactions  involving  the  importation 
or  exportation  of  goods  having  not  more  than  six  months'  sight  to 
run ;  but  no  bank  shall  accept  such  bills  to  an  amount  equal  at  any 
time  in  the  aggregate  to  more  than  one-half  of  its  paid-up  and  unim- 
paired capital  stock  and  surplus,  except  by  authority  of  the  Federal 
Reserve  Board,  under  such  general  regulations  as  said  board  may 
prescribe,  but  not  to  exceed  the  capital  stock  and  surplus  of  such 
bank,  and  such  regulations  shall  apply  to  all  banks  alike,  regardless 
of  the  amount  of  capital  stock  and  surplus. 

In  order  to  give  effect  to  the  above  amendment  of  the  law,  the 
Federal  Reserve  Board  issues  the  appended  Regulation  K,  series  of 
1915,  stating  the  conditions  under  which  member  banks  may  accept, 
up  to  100  per  cent,  of  their  capital  and  surplus,  drafts  or  bills  of 
exchange  growing  out  of  transactions  involving  the  importation  or 
exportation  of  goods  and  having  not  more  than  six  months'  sight 
to  run. 

CHARLES  S.  HAMLIN, 

Governor. 
H.  PARKER  WILLIS, 

Secretary. 

FEDERAL  RESERVE  BOARD 

WASHINGTON,  May  8,  1915. 

CLEARINGS  BETWEEN   FEDERAL  RESERVE  BANKS 


"  The  Federal  Reserve  Board  shall  make  and  promulgate  from  time 
to  time  regulations  governing  the  transfer  of  funds  and  charges  there- 
for among  federal  reserve  banks  and  their  branches,  and  may  at  its 


838  APPENDICES 

discretion  exercise  the  functions  of  a  clearing  house  for  such  federal 
reserve  banks,  or  may  designate  a  federal  reserve  bank  to  exercise 
such  functions,  and  may  also  require  each  such  bank  to  exercise  the 
functions  of  a  clearing  house  for  its  member  banks." 

II 

GENERAL   PROVISIONS 

In  the  exercise  of  the  functions  of  the  clearing  house  authorised 
under  the  provisions  of  section  16,  quoted  above,  the  Federal  Reserve 
Board  and  the  federal  reserve  banks  will  be  governed  by  and  subject 
to  the  following  regulations  and  the  Federal  Reserve  Board  will  be 
the  custodian  of  the  funds  hereinafter  termed  the  gold  settlement 
fund.  The  board  will  appoint  a  settling  agent  who  shall  keep  the 
necessary  records  and  accounts. 

Ill 

DEPOSITS   TN   THE  GOLD   SETTLEMENT  FUND 

(a)  Each  federal  reserve  bank  shall,  not  later  than  May  24,  1915, 
forward  to  the  Treasury  or  the  nearest  Sub-Treasury,  for  credit  to 
the   account   of  the   gold   settlement   fund   $1,000,000   in   gold,   gold 
certificates  or  gold  order  certificates,  and,  in  addition,  an  amount  at 
least  equal  to  its  net  indebtedness  due  to  all  federal  reserve  banks. 

(b)  The  Treasurer  of  the  United  States  or  Assistant  Treasurer 
will,  in  accordance  with  arrangements  made  with  the  Treasury  De- 
partment, advise  the  Federal  Reserve  Board,  by  mail  or  telegraph, 
of  the  receipt  of  all  funds  deposited  on  account  of  the  gold  settlement 
fund,  and  the  Treasurer  will  issue  and  deliver  to  the  Federal  Reserve 
Board  gold  order  certificates   made   "  payable  to   the   order   of   the 
Federal  Reserve  Board  "  covering  the  sum  so  deposited. 

(c)  Each  federal  reserve  bank  shall  maintain  a  balance  in  the  gold 
settlement  fund  of  not  less  than  $1,000,000. 

(d)  Excess  balances  may,  at  the  convenience  of  each  federal  re- 
serve bank,  remain  deposited  with  the  gold  settlement  fund. 

IV 

CUSTODY   OF   FUNDS 

(a)  A  safe  in  the  Treasury  vault  will  be  set  apart  for  the  ex- 
clusive use  of  the  Federal  Reserve  Board. 

(b).  To  open  the  Treasury  vault,  the  presence  of  two  persons 
designated  by  the  Secretary  of  the  Treasury  is  required.  The  com- 
bination of  the  safe  set  apart  for  the  use  of  the  board  will  be  con- 
trolled by  two  persons  designated  by  the  board. 

(c)  A  vault  record  shall  be  kept,  giving  a  memorandum  of  all 
entrances  to  the  safe,  by  whom  made,  for  what  purpose,  and  the  cer- 


APPENDICES  839 

tificates  deposited  or  withdrawn.     Each  entry  on  the  vault  record 
book  shall  be  signed  by  the  persons  having  access  to  the  safe. 


ACCOUNTS  i 

In  its  relations  with  other  federal  reserve  banks  each  federal  re- 
serve bank  shall  keep  an  account  showing  balances  "  due  to  "  other 
federal  reserve  banks  representing  the  proceeds  of  items  which  it 
has  actually  collected,  and  payments  and  transfers  which  have  been 
made  to  it  for  the  account  of  such  other  federal  reserve  banks;  and 
an  account  showing  balances  "  due  from  "  other  federal  reserve  banks 
representing  the  proceeds  of  items  which  it  has  sent  to  such  other 
federal  reserve  banks,  and  payments  and  transfers  which  have  been 
made  to  such  other  federal  reserve  banks  for  its  account. 

VI 

PROCEDURE 

(a)  At  the  close  of  business  each  Wednesday  night,  each  federal 
reserve  bank  shall  telegraph  to  the  Federal  Reserve  Board,  confirm- 
ing such  telegram  by  mail,  the  amounts  in  even  thousands  due  to  each 
other  federal  reserve  bank  as  of  that  date,  as  indicated  by  its  "  due  to  " 
account  provided  for  in  Rule  V.     If  Wednesday  is  a  holiday  in  the 
State  in  which  a  federal  reserve  bank  is  located,  then  such  bank  shall 
telegraph  as  herein  provided  on  Tuesday,  at  the  close  of  business. 

(b)  The  settling  agent  shall,  on  each  Thursday,  make  the  proper 
debits  and  credits  in  the  accounts  of  each  federal  reserve  bank  with 
the  gold  settlement  fund,  and  shall  telegraph  to  each  bank  the  amounts, 
in  even  thousands,  of  credits  to  its  settlement  account,  giving  the 
name  of  each  federal  reserve  bank  from  which  each  of  its  credits 
was  received  and  also  its  net  debit  or  credit  balance  in  the  weekly 
settlement. 

(c)  Each  federal  reserve  bank  shall,  on  receipt  of  the  telegram 
from  the  settling  agent,  debit  the  "  due  to  "  federal  reserve  banks' 
accounts,  and  shall  credit  the  gold  settlement  fund;  and  shall  credit 
the  "  due  from  "  federal  reserve  banks'  accounts  and  charge  the  gold 
settlement  fund.     The  difference  between  the  total  debits  and  credits 
shall  equal  the  net  debit  or  credit  to  the  gold  settlment  fund,  as  ad- 
vised in  the  telegram  from  the  settling  agent. 

VII 

DEFICITS 

(a)  Should  the  debit  settlement  balance  of  any  federal  reserve 
bank  be  in  excess  of  the  amount  of  its  credit  in  the  gold  settlement 
fund,  such  deficit  must  be  immediately  covered  either  by  the  deposit 
of  gold,  gold  certificates,  or  gold  order  certificates  in  the  Treasury  or 


840  APPENDICES 

nearest  Sub-Treasury,  or  by  credit  operations  with  other  federal  re- 
serve banks  which  have  an  excess  balance  with  the  gold  settlement 
fund.  Any  delay  in  covering  such  deficit  shall  be  subject  to  such 
charge  as  the  Federal  Reserve  Board  may  impose. 

(b)  As  required  in  III  (c)  of  this  regulation,  each  federal  reserve 
bank  shall  maintain  a  balance  in  the  gold  settlement  fund  of  not  less 
than  $1,000,000.  Should  the  credit  balance  of  any  federal  reserve 
bank  in  such  fund  fall  below  $1,000,000,  such  bank  shall  restore  its 
balance  to  that  amount  in  either  manner  indicated  under  VII  (a)  of 
this  regulation  on  or  before  Tuesday  of  the  following  week. 

VIII 

EXCESS   BALANCES 

Any  excess  balance  shall,  on  request,  either  by  telegraph  or  letter, 
of  the  federal  reserve  bank  to  which  it  is  due,  be  refunded  by  the 
return  to  the  reserve  bank  of  the  gold  order  certificates  held  by  the 
gold  settlement  fund  properly  indorsed;  or  by  the  indorsement  and 
delivery  to  the  Treasurer  of  a  like  amount  of  such 'certificates  for 
which  he  will  give  in  exchange  bearer  gold  certificates,  which  the 
Federal  Reserve  Board  may  send  by  registered  mail,  insured,  to  the 
banks,  if  they  want  funds  other  than  gold  order  certificates,  or  in  lieu 
of  such  payment,  the  Treasurer  may  by  wire  or  mail  direct  payment 
to  be  made  by  a  Sub-Treasury  office  through  the  medium  of  the 
general  account,  provided  funds  are  held  in  such  office  available  for 
the  purpose.  Gold  order  certificates  will,  when  presented  at  the  office 
of  the  Treasurer  of  the  United  States  or  any  Sub-Treasury,  bearing 
the  signatures  of  duly  authorised  officers  of  the  federal  reserve  bank, 
be  payable  in  gold  or  gold  certificates.  If  the  Treasury  finds  it  neces- 
sary to  ship  from  one  point  to  another  in  order  to  have  the  gold  or 
gold  certificates  available  at  the  Sub-Treasury  to  which  such  gold 
order  certificates  are  presented,  the  Federal  Reserve  Board  will,  for 
the  account  of  the  gold  settlement  fund,  refund  any  expense  incurred 
by  the  Treasury  in  making  such  shipments. 

IX 

RESERVE 

Each  federal  reserve  bank  shall  count  as  a  part  of  its  legal  reserve 
the  funds  standing,  to  the  credit  of  its  account  on  the  books  of  the 
gold  settlement  fund. 

X 

EXPENSES 

Cost  of  operation  of  and  shipment  of  currency  by  the  gold  settle- 
ment fund  shall  be  apportioned  by  a  semi-annual  accounting  among 


APPENDICES  841 

the  12  federal  reserve  banks  on  a  basis  to  be  hereafter  determined  by 
the  board  after  consultation  with  the  federal  reserve  banks. 


i 

i  XI 

AUDIT 

At  least  once  in  each  three  months  an  audit  shall  be  made  of  the 
gold  settlement  fund  by  a  representative  of  the  Federal  Reserve 
Board  and  a  representative  appointed  by  the  federal  reserve  banks. 

XII 

The  Federal  Reserve  Board  reserves  the  right  to  add  to,  alter,  or 
amend  these  regulations. 

CHARLES  S.  HAMLIN, 

Governor. 
H.  PARKER  WILLIS, 

Secretary. 


FEDERAL  RESERVE  BOARD 

WASHINGTON,  June  7,  1915. 

MEMBERSHIP  OF  STATE  BANKS 
I 

STATUTORY   REQUIREMENTS 

Specific  provisions  of  the  Federal  Reserve  Act  applicable  to  State 
banks  and  trust  companies  which  become  member  banks  are  quoted 
at  the  end  of  this  regulation. 

II 

BANKS   ELIGIBLE  FOR   MEMBERSHIP 

A  State  bank  or  a  trust  company  to  be  eligible  for  membership  in 
a  federal  reserve  bank  must  comply  with  the  following  conditions: 

(1)  It  must  have  been  incorporated  under  a  special  or  general 
law  of  the  State  or  district  in  which  it  is  located. 

(2)  It  must   have   a   minimum  paid-up   unimpaired   capital   stock 
as  follows: 

In  cities  or  towns  not  exceeding  3,000   inhabitants,   $25,000. 

In  cities  or  towns  exceeding  3.000  but  not  exceeding  6,000  in- 
habitants, $50,000. 

In  cities  or  towns  exceeding  6,000  but  not  exceeding  50,000  in- 
habitants, $100,000. 

In  cities  exceeding  50,000  inhabitants,  $200,000. 


842  APPENDICES 


III 

APPLICATION    FOR   MEMBERSHIP 

Any  eligible  State  bank  or  trust  company  may  make  application 
on  Form  83,  made  a  part  of  this  regulation,  to  the  federal  reserve 
agent  of  its  district  for  an  amount  of  capital  stock  in  the  federal 
reserve  bank  of  such  district  equal  to  6  per  cent,  of  the  paid-up 
capital  stock  and  surplus  of  such  State  bank  or  trust  company.1 

Upon  receipt  of  such  application  the  federal  reserve  agent  shall 
submit  the  same  to  a  committee  composed  of  the  federal  reserve 
agent,  the  governor  of  the  federal  reserve  bank,  and  at  least  one  other 
member  of  the  board  of  directors  of  such  bank,  to  be  appointed  by 
such  board,  but  no  Class  A  director  whose  bank  is  in  the  same  city 
or  town  as  the  applying  bank  or  trust  company  shall  be  a  member  of 
such  committee.  This  committee  shall,  after  receiving  the  report  of 
such  examination  as  may  be  required  by  the  federal  reserve  bank  in 
pursuance  of  directions  from  the  Federal  Reserve  Board,  consider 
the  application  and  transmit  it  to  the  Federal  Reserve  Board  with 
its  report  and  recommendations. 

IV 

APPROVAL   OF   APPLICATION 

In  passing  upon  an  application  the  Federal  Reserve  Board  will  con- 
sider especially: 

1 i )  The  financial  condition  of  the  applying  bank  or  trust  company 
and  the  general  character  of  its  management. 

(2)  Whether  the  nature  of  the  powers  exercised  by  the  said  bank 
or  trust  company  and  its  charter  provisions  are  consistent  with  the 
proper  conduct  of  the  business  of  banking  and  with  membership  in 
the  federal  reserve  bank. 

(3)  Whether  the  laws  of  the  State  or  district  in  which  the  apply- 
ing bank  or  trust  company  is  located  contain  provisions  likely  to  in- 
terfere with  the  proper  regulation  and  supervision  of  member  banks. 

If,  in  the  judgment  of  the  Federal  Reserve  Board,  an  applying 
bank  or  trust  company  conforms  to  all  the  requirements  of  the  Fed- 
eral Reserve  Act  and  these  regulations,  and  is  otherwise  qualified  for 
membership,  the  board  will  issue  a  certificate  of  approval.  When- 
ever the  board  may  deem  it  necessary,  it  will  impose  such  conditions 
as  will  insure  compliance  with  the  act  and  these  regulations.  When 
the  certificate  of  approval  and  any  conditions  contained  therein  have 
been  accepted  by  the  applying  bank  or  trust  company,  stock  in  the 
federal  reserve  bank  of  the  district  in  which  the  applying  bank  or 
trust  company  is  located  shall  be  issued  and  paid  for  under  the  regu- 

1  Three  per  cent,  has  already  been  called  from  national  and  other  member 
banks,  but  the  remainder  of  the  subscription  or  any  part  of  it  shall  be  sub- 
ject to  call  if  deemed  necessary  by  the  Federal  Reserve  Board. 


APPENDICES  843 

lations  of  the  Federal  Reserve  Act  provided  for  national  banks  which 
become  stockholders  in  the  federal  reserve  banks. 


POWERS   AND  RESTRICTIONS 

Every  State  bank  or  trust  company  while  a  member  of  the  federal 
reserve  system  : 

(1)  Shall  retain  its  full  charter  and  statutory  rights  as  a  State 
bank  or  trust  company,  and  may  continue  to  exercise  the  same  func- 
tions as  before  admission,  except  as  provided  in  the  Federal  Reserve 
Act  and  the  regulations  of  the  Federal  Reserve  Board,  including  any 
conditions  embodied  in  the  certificate  of  approval. 

(2)  Shall  invest  only  in  loans  on  real  estate  or  mortgages  of  a 
character  and  to  an  extent  which,  considering  the  nature  of  its  liabili- 
ties, will  not  impair  its  liquid  condition. 

(3)  Shall  adjust,  to  conform  with  the  requirements  of  the  Federal 
Reserve  Act  and  these  regulations,  within  such  reasonable  time  as 
may  be  determined  by  the  board  in  each  case,  any  loans  it  may  have 
at  the  time  of  its  admission  to  membership  which  are  secured  by  its 
own  stock,  or  any  loans  to  one  person,  firm,  or  corporation  aggregat- 
ing more  than  10  per  cent,  of  its  capital  and  surplus  or  more  than  30 
per  cent,  of  its  capital,  or  any  real  estate  loans  which,  in  the  judg- 
ment of  the  Federal  Reserve  Board,  impair  its  liquid  condition. 

(4)  Shall  maintain  such  improvements  and  changes  in  its  banking 
practice  as  may  have  been  specifically  required  of  it  by  the  Federal 
Reserve  Board  as  a  condition  of  its  admission,  and  shall  not  lower 
the  standard  of  banking  then  required  of  it :  and 

(5)  Shall  enjoy  all  the  privileges  and  observe  all  those  require- 
ments of  the  Federal  Reserve  Act  and  of  the  regulations  of  the  Fed- 
eral Reserve  Board  applicable  to  State  banks  and  trust  companies 
which  have  become  member  banks. 

VI 

WITHDRAWALS 

Any  State  bank  or  trust  company  desiring  to  withdraw  from  mem- 
bership in  a  federal  reserve  bank  may  do  so  twelve  months  after 
written  notice  of  its  intention  to  withdraw  shall  have  been  filed  with 
the  Federal  Reserve  Board.  The  board  will  immediately  notify  the 
federal  reserve  bank  of  the  receipt  of  such  notice.  At  the  expira- 
tion of  said  twelve  months,  such  bank  or  trust  company  shall  sur- 
render all  of  its  holdings  of  capital  stock  in  the  federal  reserve  bank, 
which  stock  shall  then  be  cancelled  and  the  withdrawing  bank  or 
trust  company  shall  thereupon  be  released  from  its  stock  subscription 
not  previously  called.  Such  bank  or  trust  company  shall,  immedi- 
ately upon  the  cancellation  of  its  stock,  cease  to  be  a  member  of  the 


844  APPENDICES 

federal  reserve  bank,  and  the  federal  reserve  bank  shall  then  refund 
to  such  bank  or  trust  company  a  sum  equal  to  the  cash-paid  subscrip- 
tion on  the  shares  surrendered,  with  interest  at  the  rate  of  one-half 
of  one  per  centum  per  month  computed  from  the  last  dividend,  if 
earned,  not  to  exceed  the  book  value  thereof,  and  the  reserve  deposits, 
less  any  liability  of  such  member  to  the  federal  reserve  bank :  Pro- 
vided, That  no  federal  reserve  bank  shall,  except  by  the  specific  au- 
thority of  the  Federal  Reserve  Board,  cancel  within  the  same  calendar 
year  more  than  10  per  cent,  of  its  capital  stock  for  the  purpose  of 
effecting  voluntary  withdrawals  during  that  year.  All  applications, 
including  therein  any  on  which  action  may  have  been  deferred  be- 
cause in  excess  of  the  aforesaid  10  per  cent,  limitation,  will  be  dealt 
with  in  the  order  in  which  they  were  originally  filed  with'  the  board. 
Any  State  bank  or  trust  company  desiring  to  withdraw  from  mem- 
bership at  the  expiration  of  the  twelve  months'  notice,  notwithstand- 
ing the  fact  that  the  federal  reserve  bank  has  previously  cancelled' 
10  per  cent,  of  its  stock  during  the  same  calendar  year,  may  do  so. 
In  such  case,  however,  the  federal  reserve  bank  shall  not  be  required 
to  repay  to  the  withdrawing  bank  or  trust  company  the  sums  due  as 
above,  until  such  time  as  its  stock  would  have  been  cancelled  had  it 
not  exercised  this  option.  The  federal  reserve  bank  shall,  however, 
give  a  receipt  for  the  stock  surrendered. 

VII 

EXAMINATIONS 

Every  State  bank  or  trust  company,  while  a  member  of  the  Federal 
Reserve  system,  shall  be  subject  to  such  examinations  as  may  be  pre- 
scribed by  the  Rederal  Reserve  Board  in  pursuance  to  the  provisions 
of  the  Federal  Reserve  Act. 

In  order  to  avoid  duplication,  the  board  will  exercise  the  broad 
discretion  vested  in  it  by  the  act  in  accepting  examinations  of  State 
banks  and  trust  companies  made  by  State  authorities  wherever  these 
are  satisfactory  to  the  board  and  are  found  to  be  of  the  same  standard 
of  thoroughness  as  national  bank  examinations,  and  where  in  addi- 
tion satisfactory  arrangements  for  co-operation  in  the  matter  of 
examination  between  the  designated  examiners  of  the  Board  and 
those  of  the  States  already  exist  or  can  be  effected  with  State  authori- 
ties. Examiners  from  the  staff  of  the  board  or  of  the  federal  reserve 
banks  will,  whenever  desirable,  be  designated  by  the  board  to  act 
with  the  examination  staff  of  the  State  in  order  that  uniformity  in 
the  standard  of  examination  may  be  assured. 

VIII 

FUTURE  REGULATIONS 

The  Federal  Reserve  Board  reserves  the  right  to  make  such  amend- 
ments and  adopt  and  issue,  from  time  to  time,  such  further  regula- 


APPENDICES  845 

tions  authorised  by  the  act  as  it  may  deem  necessary,  but  no  amend- 
ment of  section  VI  of  these  regulations,  relating  to  voluntary  with- 
drawals, shall  take  effect  until  six  months  after  its  adoption  and 
issue  by  the  board. 

CHARLES  S.  HAMLIN, 

Governor. 
H.  PARKER  WILLIS, 

Secretary. 


f/277 


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